Cash and customers are the two great accelerators of success for small- and medium-sized enterprises (SMEs) that want to grow. But securing cash and customers often ends up leaving SME owners with the proverbial chicken-and-egg question: Which comes first?  

SMEs normally work first to secure cash. But in today’s low-risk, tight-fisted lending environment, it can be difficult for SMEs to secure the cash necessary to capture new customers or enter new markets. It may require a leap of faith for SME owners and banks, unless the SME has hard assets for collateral.  

Banks love lending against hard assets, such as buildings, equipment and homes. They also can lend against other assets, but these assets must be easy to convert into cash. This includes assets such as accounts receivable (A/R) and domestic inventory.

The dilemma

There are basically two forms of A/R funding. The first is securing a revolving line of credit from a bank. It is among the most common and efficient ways for companies to get cash for day-to-day operations, such as meeting payroll and paying bills. The second form is to “factor,” or sell A/R to another company. Depending on the agreement, the company purchasing the A/R may or may not be responsible for collecting the debt, but if the debt is determined to be uncollectable, the responsibility for collection can revert back to the company that sold the A/R. This is because most factors for SMEs do not assume the credit risk.

Another method to secure cash is to include domestic inventory in the collateral base. The problem with this method is that most SMEs cannot afford to maintain warehouses full of unsold inventory. 

Warehouses—whether purchased, rented or shared—are another expense for SMEs, and inventory quickly consumes working capital. Banks may lend against inventory, however it is riskier than lending against A/R because that inventory can quickly become obsolete or undesirable to customers. 

A lending rule of thumb is to advance just 50 cents for every dollar of inventory. SMEs then need to use expensive equity to make up the balance caused by the low advance rate.

Many start-ups are typically financed through equity, first using money from savings and then turning to family and friends. However, they tend to zip through savings and friendly equity very quickly, and then find it very difficult and expensive to raise money from investors. 

There was a time a few years ago when venture capital flowed like liquid gold. But those risk-loving investors are not as prevalent anymore. Finding debt or equity in today’s nervous credit markets presents many challenges to deserving companies that need that extra boost. 

Given the high cost of warehousing and equity, SMEs who import goods find it much less expensive to “warehouse” their inventories in containers aboard ships bound from China, Colombia, India and other countries with low-cost production. But this tactic usually prevents them from using onboard inventory as collateral for loans from traditional lenders.

Too many SMEs think their only option is to wait to purchase new inventory until they collect cash by selling inventory from previous shipments. This can lead to a cyclical cash-flow dependency that can inhibit SMEs from growing. 

This dilemma is compounded by the current insecurity of financial institutions. It will take many years before these institutions acquire the same appetite for risk they had before the recession, and “floating” incoming inventory from international locations is usually considered very high risk. 

Many SMEs are looking for loans in all the wrong places as they seek traditional financing from traditional lenders. And even if they find a new source of financing, many SMEs make the tactical blunder of mismatching their business strategies and deployment of funds. These errors can cause SMEs with great growth potential to remain static. 

The solution

Fortunately, new sources for financing are now available. Today’s tracking technologies enable logistics companies and carriers to pinpoint the exact location of customers’ inventories throughout their supply chains. This visibility has spurred new entrants into the world of financing imports and exports. The unprecedented comfort of knowing where goods are located at all times minimizes the risk of lending against the value of in-transit inventories. This is particularly true if the financial provider and the logistics company are related entities.

This new avenue of cash flow can help SMEs avoid mismatching financing with growth tactics. For example, A/R financing, when properly used, should be the bait that SMEs use to attract new customers. If competitors offer 30-day financing, then SMEs can benefit by offering 45-day or 60-day terms. SMEs should use A/R financing to provide these trade terms and lure new customers from competitors.

However, many SMEs mistakenly utilize A/R financing to buy more products. This can prevent them from acquiring new customers because they are using this working capital to purchase inventory instead of offering extended trade terms. 

Successfully implementing a business strategy, such as acquiring new customers, should have a corresponding financial tactic. A/R financing should be used to finance extended trade terms to acquire new customers. Inventory financing should be used to regulate inventory levels, and in particular, in-transit inventory financing should be used to finance imports. Equipment financing should be used for equipment purchases.  

For growing SMEs that may be struggling to find the right financing options, the message is to not give up. There are lenders and loans available, but companies may need to consider non-traditional lenders and financing methods. Today, the availability of and access to data enables non-traditional lenders to enter the market and help finance SMEs who want to take the leap from good to great.

In short, SMEs should seek partners that can offer a broader portfolio of logistical and financial products and services to obtain better financing.

And once financing is secured, SMEs must set their strategy, such as growth into new markets or developing new products, and use the appropriate financial tactics to achieve those strategies. Looking for financing in the right places and then using that financing appropriately are fundamental for SMEs to grow. 

Survey: Retailers Continue to Shop for Banks A new survey by the Association for Financial Professionals (AFP) finds that many retailers have been shopping for different banks. Last year, 80 percent of retailers ended an existing bank relationship, usually to trim costs, according to a new survey by the AFP. Meanwhile, 90 percent of retailers added a new banking relationship, either to obtain better pricing (53 percent), to diversify risk (29 percent) or to secure access to credit (24 percent). The 2011 AFP Retail Industry Survey, underwritten by Fifth Third Bank and released in May, analyzes responses from finance departments of 111 retailers—an industry that has experienced significant volatility. In fact, nearly 30 percent of respondents said they had altered bank relationships in the last 18 months due to major changes in their retail businesses, whether from contraction (exiting markets/ store closings) or expansion (new markets/ store openings). Significantly, among retailers adding new banks for this reason, 40 percent seek banks to handle business expansion overseas. “The previous few years have seen a make-or-break time for many businesses,” said Jeff Ficke, senior vice president and Director of Treasury Management for Fifth Third Bank. “Those who prospered during this economic downturn are taking their companies to the next level and are looking for established banks that can help them assimilate into a global economy.” In support of this dynamic industry, many banks are adding core retail banking services, according to 43 percent of respondents; other banks are dropping some of these services, say 13 percent of respondents. At the same time, banks are pressuring retailers to buy more than core retail services, according to 54 percent of respondents –– and nearly 30 percent of retailers surveyed say that they are indeed expanding relationships with the banks that request this increase. Looking ahead, AFP expects to see retailers continue to alter their mix of banks because more than 90 percent of retail bank fees link to merchant card or cash management services that may be affected by new regulations for financial institutions. These include changes in interchange rates, interest on demand deposits, and FDIC insurance limits. Of respondents, 77 percent believe these regulatory changes might have an impact on bank relationships. “Regulatory change and economic uncertainty are likely to continue to affect retailers in the foreseeable future,” said Thomas Hunt, AFP’s director of treasury services. “Effective partnerships between corporate treasurers and their bankers will help retailers weather these changes.” As with any relationship, those between retailers and their banks often are based upon closeness and value. The survey found that a bank’s proximity to store locations was the single biggest factor in a retailer’s bank choice (29 percent of respondents), followed by cost/value of services (28 percent), and the bank’s willingness to provide credit to the retailer (27 percent). Of the many challenges that can complicate the management of bank relationships, the biggest for retailers may come down to a difference in philosophy: 37 percent of respondents see difficulty maintaining a long-term view of the relationship when their bank partners are short-term focused. “Retailers are looking for banks to be more than just a vendor of products,” said Ficke. “The more banks are able to provide a holistic, consultative approach to retailers with solutions to meet the challenges they are facing, the more likely the retailer is to stay with them. As long as retailers feel banks are treating them like a number instead of a stakeholder, we will continue to see the movement from bank-to-bank.” The entire AFP survey is available online at www.afponline.org/retailsurvey.