Fixing our business banking system is the most effective way to get our economy growing
Every business should have a contingency plan to deal with an unexpected dip in cash flow. While simply having a business overdraft available provides some degree of short-term protection, it’s best to have an array of lifelines at your disposal. Also, we find that the overdraft gets used for everyday purposes rather than for unexpected problems.
Peer-to-peer financing is another clever route to addressing temporary dips in cash flow. Conventional peer-to-peer financing involves online companies lending to businesses from funds gathered through a pool of investors. These loans are usually quicker and more straightforward than conventional borrowing and there is no minimum amount, so they are perfect for topping up cash flow. Beware: some offer much better value than others: don't be taken in by headline rates, do some calculations or check with your accountant.
Another smart take on peer-to-peer financing is an online improvement on invoice ‘factoring’, whereby a business in need of cash sells its ledger to a bank or another conventional lender. The online providers in this area of peer-to-peer financing, which include InvoiceX, will buy (for 1.5-3% per month) individual invoices – allowing companies to easily draw specific, limited amounts – but avoid the hidden fees, long contracts and slow decision processes of traditional factoring providers. For working capital spikes, this is often a better ongoing solution than a short term loan which can cause more cashflow problems a few months later. Importantly, watch out for whether your customer needs to be notified.
Insightful analysis by Alan Kohler in The Australian this weekend on what is holding business back and the negative effects on our economy. Sadly, our politicians seem to be disconnected from the reality of how to manage our economy.
"A small business tax break is worthwhile perhaps, and likewise an RBA rate cut, and in each case it’s really all the government and the central bank can do."
The Government could get involved investing modest sums on alternative finance platforms, like the UK Government did 3 years ago with powerful positive effects (and good returns on investment).
That would help overcome people's natural caution and skepticism. People tend to think that banks have some super-natural powers in deciding who is creditworthy. Overseas' experience makes it clear that they are simply expensive, bureaucratic building societies that have lost their way.
My father was a bank manager and retired when the computer took away his discretion. Bank managers in his days had real discretion and could support businesses with their growth plans. We need to re-invent banking by going back to why they came into existence in the first place. It had nothing to do with household mortgages which simply inflated the price of unproductive assets.
Here's a more detailed extract from Alan's article:
APRA, in line with global bank regulators, has also told them to increase their capital ratios, and since the system of risk-weighting means that only a quarter of the value of a real estate mortgage is counted against capital versus 100 per cent of a loan secured only against a business, that means all lending these days is more or less confined to mortgages.
It means the banks are basically not lending to those who don’t own a house or are already fully committed on their mortgages, and those who are building houses for investors.
So they are going elsewhere and paying 10-15 per cent more in interest than the banks would charge, except they’re not.
It means the divide between the haves and have-nots (a house, that is) has never been this great, and it’s also why this week’s rate cut by the Reserve Bank will make no difference and why the government’s efforts in the budget to help small businesses and middle income earners will only scratch the surface.
Banks actually run the economy by both creating money and circulating it, not the RBA or the government, and these days banks are only serving those who have equity in real estate.
According to economist Saul Eslake, home ownership rates among households headed by people aged 25 to 55 have dropped by an average of 9 per cent since 1991.
Most dramatically, the rate of home ownership among 25-34 year olds has fallen from 61 per cent in 1981 to 47 per cent in the latest census.
That is a huge social change: in one generation the number of families starting out and having children who also own their own home has dropped from almost two-thirds to less than half, and in the past 10 years the decline is accelerating.
It means the number of young people able to get a bank loan to start or expand a business, or to get a car loan or personal loan for anything less than 15 per cent interest, has also fallen significantly.
And a lot of that change is caused by the real estate market distortion inherent in negative gearing and the capital gains tax discount, which rewards highly geared property investors at the expense of owner-occupiers, who are in turn paying higher taxes than they otherwise would be in order to fund the subsidy to property investors.
So the combination of high house prices caused, in part, by negative gearing and the capital gains discount, with the transformation of banks into little more than building societies that lend almost exclusively against real estate, is the reason growth is weak.
A small business tax break is worthwhile perhaps, and likewise an RBA rate cut, and in each case it’s really all the government and the central bank can do.
But what’s really crimping entrepreneurship and growth is the post-GFC change to banking.
It means business people looking to expand have to come to Shylocks like your correspondent.
Most don’t bother.
A business with a poor credit rating can find it difficult to access loans and other financial services. That’s why we have analysed some credit agency models and found a few simple ways to boost your score, and avoid unnecessary exclusion.
Be careful about shopping around for credit
Business owners are generally not aware that shopping around for credit can have quite a negative effect on your credit score. Try to get good advice before applying for credit. Read this article for more information.
Improve the way you file with ASIC and prepare accounts
File your annual return on time – being prompt won’t necessarily boost your rating, but being late can cause problems.
Prepare your accounts on time, Use accountancy software like Xero or MYOB to keep everything in check, and work with your accountant to prepare everything you need in good time. Keeping everything on-line makes this much easier.
Use a reputable accountant. This doesn’t mean you need to go to one of the ‘big 4′ professional services firms like. A well-practiced local accountant who is an ACA or CPA is just as good. Annual accounts from a trustworthy source will give your business real legitimacy and boost your credit rating.
Avoid complicated corporate structures
Keeping your business’ structure simple (e.g. a proprietary limited company) makes it easier for lenders to understand and assess – instantly improving your credit rating. Too many subsidiaries or an unclear ownership structure are warning signs to potential lenders. More transparency and a clear corporate framework will give you a better credit score.
Stability at the top
If directors and board members are seen to be chopping and changing, it’s an instant sign for those looking in that trouble is brewing within a business. Try to avoid this instability as best as you can, as it undermines the rest of your business. Pick your partners for the long run and stay transparent on who controls the company. A strong leadership instills confidence, and will improve your credit rating.
Keep your net assets positive, separate business from lifestyle expenses
Make sure your total assets always outstrips your total liabilities. Some lenders will outright refuse to lend to any business that has negative net assets. This might affect those owners who use their controlled companies to pay for their lifestyle expenses. Sole traders or entrepreneurs often don’t separate their personal expenses from their company expenses. Whilst this pattern is quite typical for SMEs, such businesses will show very low or even negative net assets, with the slightest of operating margins. It’s up to you how you run your business, but beware that this behaviour will have an adverse impact on your credit score and your ability to access credit.
Keep on top of your cash flow
It’s vital to maintain a healthy balance between your current assets, payables and outstanding liabilities. Poor management of working capital can leave your business heavily exposed to its incoming payments. Don’t be afraid to negotiate credit terms with your suppliers and your customers. You can also use invoice finance to improve your cash position – the most quick and flexible option is InvoiceX of course.
It’s also important to check who you’re dealing with – do they pay on time, or do they pay late? Ask other business owners who have dealt with your prospective customer about their record. Credit check your customers, and ask to be paid promptly. Don’t accept unfair or unusually long payment terms, be prepared to walk away if these are forced upon you – it’s no good to see your business fail because of tight cash flow when you have a full order book.
Court judgements are registered against your business when your creditor has gone to court to force you to pay them and the judge has ruled in their favour. They are a fast-track to a poor credit rating – either pay them off or fight them vigorously, don’t let them fester. The more judgements you have the lower your credit score. Less than one percent of businesses in Australia have outstanding court judgements, so those that do are in a tiny minority that will suffer. Deal with them as quickly as you can.
Security interests and charges? These actually DON’T affect your credit rating.
Your credit score is impacted by the amount of debt you carry as a business, but not by what kind of security you have provided to your creditors. For example, granting a General Security Deed (contract by which you pledge all of your business assets to your creditor) doesn’t in itself impact your credit score, it just makes it necessary for any new creditor to agree with your existing creditor on how your assets will be divided up if your business should fail. If a lender wants to provide you with credit, but has to get consent from your existing creditor, don’t be afraid to ask for it. Banks in Australia are expected to ensure that the consent is provided in reasonable time and even if consent is refused, they can’t change the terms of your current lending agreement. So asking for consent won’t damage your credit rating, or your ability to get credit in the future.
Most of the time when a business is refused credit (or quoted an expensive price) it’s not the result of specific information that looks bad, it’s actually the result of a lack of information. By sharing more information about your business online, you’ll most likely find yourself a much more attractive prospective borrower.
The Basel Committee released its second consultative document on Revisions to the Standardised Approach for credit risk in December (comments due by 11 March 2016).
There has been little or no commentary about its impact on SME lending - we believe that the effects will be far reaching.
The committee pulled back from the penal ‘negative equity =>150% risk weighting’ approach that was previously proposed. Now they propose a general 85% risk weighting. This compares with a current 60% weighting so is still bad news for SMEs looking to raise finance from banks.
There are statements in the document about having to apply 100% risk weighting if due diligence requires it. The proposed revision to lease accounting (IFRS 16) could be a factor here.
So the future of SME lending remains in a state of flux, with the 'Big 4' IRB version yet to be released. The outcome is likely to have a major impact on SME lending by banks, especially as it affects mid-sized businesses that drive growth and jobs across Australia.
SMEs now only represent 15% of new business lending by banks and outstanding loans have fallen to 30% of all business lending (early ‘90s – 50%).
It is already quite uneconomic for banks to lend to SMEs and becoming more so. We believe that this downward trend is set to continue, as is happening globally.