SME Funding an Issue Says New Report

The latest edition of the Scottish Pacific SME Growth Index has been released. It gives an interesting snapshot on the critically important SME sector in Australia. Once again, as in our own SME surveys, cash-flow is king. 90% of SME owners said they faced cash-flow related issues.  That said, the non-bank sector, including Fintechs need to do more to raise awareness of the solutions they offer.

SME business confidence is on the rise finds small business owners forecasting revenue to improve during the first half of 2018.

There appears to be a splitting of the pack in SME fortunes, with a greater number of previously “unchanged” growth SMEs moving into positive or negative growth.

For most SMEs cash flow has improved compared to 12 months ago, however one in 10 say they are worse off now. The number of SMEs reporting significantly better cash flow (27%) and better cash flow (42%) will hopefully act as a major driver of new capital expenditure and business investment demand.

Despite this reported rise in cash flow, nine out of 10 SMEs say they had cash flow issues in 2017 and nine out of 10 say these issues impacted on revenue. On average, small businesses say that better cash flow would have increased their 2017 revenue by 5-10%.

For SMEs with plans to invest in expansion over the next 6 months, 24% of them report they will fund that growth by borrowing from their main relationship bank – continuing a downward trend, and well short of the high of 38% who nominated this option to fund growth in the first round of the Index in September 2014.

21.7% of SMEs say they plan to use non-bank lenders to fund upcoming growth (with 90.8% planning to use their own funds). Non-bank lending intentions have trended upwards since the first Index, closing the gap between bank and non-bank lending intentions. Despite these intentions, more than 91% of SMEs responded in H1 2018 that in the previous 12 months they had not accessed any non-bank lending options to provide working capital for their business.

So while SMEs seem unsatisfied with traditional banks, they are not yet fully accessing opportunities available to them in the non-banking sector.

Results show that growth SMEs are five times more likely to use alternative lending options than declining growth SMEs, with debtor finance the most popular option. The growth potential for the non-bank lending sector is significant, given that 48% of SMEs who didn’t use non-bank lending in 2017 are considering it for 2018.

With SME owners revealing a solid reliance on personal credit cards to give their business the working capital required for day to day operations, those with better business solutions must find a way to reach these small business people.

Businesses implementing appropriate working capital solutions to get on top of cash flow impediments are well placed to realise their growth ambitions.

DFA’s SME Report 2017 Released

The latest results from the Digital Finance Analytics Small and Medium Business Survey, based on research from 52,000 firms over the past 12 months, is now available on request.   You can use the form below to obtain a free copy of the report.

There are around 2.2 million small and medium businesses (SME) operating in Australia, and nearly 5 million Australian households rely on income from them directly or indirectly. So a healthy SME sector is essential for the future growth of the country.

However, the latest edition of our report reveals that more than half of small business owners are not getting the financial assistance they require from lenders in Australia to grow their businesses.

Most SME’s are now digitally literate, yet the range of products and services offered to them via online channels remains below their expectations.

More SME’s are willing to embrace non-traditional lenders, via Fintech, thanks to greater penetration of digital devices, and more familiarity with these new players. In addition, many firms said they would consider switching banks, but in practice they do not.

Overall business confidence has improved a bit compared with our previous report, but the amount of “red tape” which firms have to navigate is a considerable barrier to growth.

Running a business is not easy. In some industries, more than half of newly formed businesses are likely to fail within three years. We found that banks are not offering the broader advice and assistance which could assist a newer business, so even simple concepts like cash flow management, overtrading and debtor management are not necessarily well understood. There is a significant opportunity for players to step up to assist, and in so doing they could cement and strengthen existing relationships as well as creating new ones.

We think simple “Robo-Advice” could be offered as part of a set of business services.

The sector is complex, and one-size certainly does not fit all. In this edition, we focus in particular on what we call “the voice of the customer”. In the body of the report we reveal the core market segmentation which we use for our analysis and we also explore this data at a summary level.

Here is a short video summary of the key findings.

The detailed results from the surveys are made available to our paying clients (details on request), but this report provides an overall summary of some of the main findings. We make only brief reference to our state by state findings, which are also covered in the full survey. Feel free to contact DFA if you require more information, or something specific. Our surveys can be extended to meet specific client needs.

Note this will NOT automatically send you our research updates, for that register here.

SME Cash Flow Under Continued Pressure

We have updated our rolling SME survey, ahead of the next edition of the SME report, out soon. The previous version is still available on request. SME’s are under significant cash flow pressure. Today we walk though some of our findings.

We look at businesses up to $5m turnover, although most of the 2 million plus businesses are much smaller.

The average age of the owner is more likely to be 45-55 years, as often they have moved on to second careers, or decided to set up on their own.

Nearly half are less than 4 years old, and indeed more than half started are likely to fail in the first 3 years.

Construction and Real Estate services make up a large proportion of the total, and the SME sector overall is heavily relent on the property sector more broadly.

Around 60% of businesses are seeking to borrow, and most are looking for working capital support.

The main driver within working capital is delayed payments (especially from large private sector companies and some government agencies).

The average debtor days is more than 50 days and rising. It varies by state.

Our risk analysis metric shows that businesses in the other services and construction sectors are most risky when it comes to finance. Health care businesses are the lowest risk.

Next time we will look further at SME finances and their channel usage.

Yes, SME’s ARE Getting The Damp End of the Stick from the Banks

An inquiry into small business loans by the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) Kate Carnell, has found the big four banks consistently engage in practices that have caused significant harm to some small business customers. The ASBFEO inquiry investigated a selection of cases examined as part of the Parliamentary Joint Committee Inquiry into the Impairment of Customer Loans.

This report confirms what our SME surveys show – small business has an unequal relationship with their banks, have difficulty getting the finance they need on fair terms, and find that lenders bully them especially in times of hardship. That said, SME’s often are unable or unwilling to shop around to get better deals, and feel trapped by the current arrangements. You can a video on our analysis here, and get the free copy of the DFA report here. SME’s are a critical engine in the economy, and current banking behaviour towards them is a brake on growth.

The ASBFEO report has made a significant number of recommendations.

  • Strengthen the Australian Bankers’ Association’s six-point plan;
  • Code of Banking Practice be revised to include a specific small business section, with the Code to be approved and administered by ASIC;
  • No defaults on loans below $5 million where a small business has made payments and acted lawfully;
  • A minimum 30-business day notice period for potential breach of contract conditions;
  • A minimum 90-business day notice period for bank rollover decisions for loans below $5 million (longer for rural properties and complex businesses);
  • Banks required to provide a one-page summary of loan default triggers;
  • Banks to put in place a new and clearly written small business standard form contract;
  • Borrowers be provided with a choice of valuer, vauler instructions and valuation report;
  • Borrowers be provided a copy of instructions given to investigating accountants and the subsequent report;
  • Banks to eliminate perceived conflict of interest when investigating accountants appointed as receivers;
  • An industry-funded one-stop external dispute resolution body, with a unit dedicated to resolving small business disputes regarding credit facilities of up to $5 million;
  • Bank customer advocates be made available to consider small business complaints;
  • External disputes resolution schemes be extended to include disputes with third parties appointed by the bank and to borrowers who have undertaken farm debt mediation.
  • A national approach to farm debt mediation;
  • ASIC to establish a Small Business Commissioner.

The ASBFEO inquiry – completed in just over three months – investigated the circumstances surrounding a number of cases of alleged small business mistreatment by the banks, and concluded loan contract arrangements between banks and small businesses, put the borrower at a distinct disadvantage.

“Fundamentally, what we’ve found is that small businesses who take out a loan, do so under the impression that if they keep up their payments, they will stay out of trouble.  The reality is that this is not the case; that the clauses contained in standard small business loan contracts give banks an inordinate level of power over the borrower, who has zero ability to do anything about it,” Ms Carnell said.

“Basically, the terms in these contracts allow the bank to take action to protect itself from financial risk, by inflicting added demands on the borrower.

“For example, banks may conduct a new valuation on the assets securing the loan.  Now if the value is found to have fallen, the borrower faces significantly increased – and potentially unmanageable – loan costs.  Banks also have the power to unexpectedly call in the loan, and demand repayment in an unrealistic timeframe.

“So what ends up happening is that through no fault of their own, small businesses could quickly find themselves in default, even though they’ve made each loan payment, on time, every time.

“The banks argue that they don’t use these contract clauses, however our inquiry found this is simply not true; that banks do in fact utilise these clauses, much to the surprise and heart-break of their small business borrowers,” she said.

Ms Carnell said the ASBFEO report outlines recommendations that can be implemented – many in a short timeframe – to help alleviate the vulnerability of small business borrowers when entering contracts, while not impacting on the financial viability of the banks.

“The cases we examined during our inquiry highlighted the glaring need to ensure small business bank customers are provided with simple standard contracts that are written in plain English and that get rid of the clauses giving banks all the power,” Ms Carnell said.

“It’s also clear from the cases we looked at, that current thresholds governing small business external dispute resolution are insufficient, so we will certainly support work in establishing a mechanism to provide timely and affordable access to justice for cash-strapped small businesses,” she said.

Ms Carnell said the ASBFEO will publish six monthly scorecards on the progress banks are making in response to the recommendations contained in the ASBFEO report.

“Since the GFC there have been 17 inquiries and reviews that have produced more than 40 recommendations over the years, relating to the small business sector.  Despite this, the banks have consistently failed to implement changes to address persistent problems” Ms Carnell said.

“Frankly, the banks take ‘kicking the can down the road’ to new levels.  This is no longer acceptable and I’m determined the recommendations we’ve made are adopted as quickly as possible.  This report is a living document; it’s only the beginning of our work in this area,” she said.

Ms Carnell said she hopes that as industry leaders, the four major banks will seize the opportunity to be exemplars for change, saying the ASBFEO has already secured varying levels of in–principle support from the banks on a range of issues.

“While there’s certainly a lot of work to be done, it’s important to give credit where it’s due, with the big four banks committing – albeit to varying degrees – to make changes in a number of problem areas identified during our inquiry process,” Ms Carnell said.

These include amending the Code of Banking Practice to provide greater small business protections, the creation of customer advocates and improved transparency on valuations.


On 6 September 2016, the Minister for Small Business, the Hon. Michael McCormack MP, tasked the ASBFEO with undertaking an inquiry into the adequacy of the law and practices governing financial lending to small businesses.

The ASBFEO inquiry investigated a selection of cases examined as part of the Parliamentary Joint Committee Inquiry into the Impairment of Customer Loans.

Throughout the inquiry process executives from the four major banks were summonsed to attend public hearings, with the ASBFEO using its Royal Commission-like powers to compel banks to produce required case documentation.  The inquiry also heard evidence from bank customers during private hearings, and considered the findings of previous inquiries and reviews.

The Financing of Nonemployer Firms

From The St. Louis Fed Blog.

Nonemployer firms that applied for financing were more likely to operate at a loss, according to the recently released 2015 Small Business Credit Survey: Report on Nonemployer Firms.

This report, produced jointly by the Federal Reserve banks of St. Louis, Atlanta, Boston, Cleveland, New York, Philadelphia and Richmond, examined trends in businesses with no employees other than the owners. As the report noted, these businesses make up nearly 80 percent of all U.S. firms.

Applying for Financing

The report noted that 32 percent of survey respondents said they applied for financing in the previous 12 months. Among those who applied, the most common reason (66 percent) was to expand the business or to take advantage of a new opportunity. The next most common reason (38 percent) was to cover operating expenses. (Respondents could select multiple answers.)

Among those businesses that did not apply for financing, the top three reasons were:

  • Debt aversion (33 percent)
  • Already had sufficient financing (30 percent)
  • Believed they would be turned down (25 percent)

Profitability: Applicants vs. Nonapplicants

As the report noted: “Collectively, applicants were less profitable than the nonapplicants.” The figure below shows the difference.

profitability of small businesses that applied for financing

Financing Approval

Among firms that applied for financing, 41 percent were not approved for any of the funding they sought. The percentages of firms not receiving any funding grew smaller as firms grew larger: 48 percent of firms with less than $25,000 in revenue did not receive any funding, while only 28 percent of firms with revenues greater than $100,000 did not receive funding.

About 71 percent of firms received less financing than the amount sought. When asked about the primary impact of this financing shortfall, the top response (33 percent) said the firm had to delay expansion. Other top answers were that they used personal funds (22 percent), were unable to meet expenses (18 percent) and passed on business opportunities (13 percent).

Additional Resources

How speeding up payments to small businesses creates jobs

From The US Conversation.

Speeding up payments to SME’s would have a major positive impact. Operating a small business, the backbone of the U.S. economy, has always been tough. The same is true in Australia, and cash flow is a major challenge, as data from our SME survey shows:

According to The Conversation, SME’s also been disproportionately hurt by the Great Recession, losing 40 percent more jobs than the rest of the private sector combined.

Interestingly, as my research with Harvard’s Ramana Nanda shows there’s a fairly straightforward way to support small businesses, make them more profitable and hire more: pay them faster.

A major source of financing

When a business is not paid for weeks after a sale, it is effectively providing short-term financing to its customers, something called “trade credit.” This is recorded in the balance sheet as accounts receivable.

Despite its economic importance, trade credit has received little attention in the academic literature so far, relative to other sources of financing, yet it is a major source of funding for the U.S. economy. The use of trade credit is recorded on companies’ accounting statements as “trade payables” in the liability section of the balance sheet. According to the Federal Fund Flows, trade payables amounted to US$2.1 trillion on nonfinancial companies’ balance sheets at the end of the third quarter of 2006, two times more than bank loans and three times as much as a short-term debt instrument known as commercial paper.

Recent news reports have highlighted the problem of slow payments to suppliers as large companies extend their payment periods, often with crushing results for small businesses.

Other countries have tried to reform the trade credit market, especially in Europe, where a directive was adopted in 2011 limiting intercompany payment periods for all sectors to 60 days (with a few exceptions).

In an earlier paper, I showed that requiring payments to be made within shorter time periods had a large effect on small businesses’ survival when it was adopted in France. Receiving their money earlier led them to default less often on their own suppliers and their financiers. Their probability to go bankrupt dropped by a quarter.

Accelerating payments

To learn more about the impact of such reforms in the U.S., we studied the effects of speeding up payments to federal contractors.

The QuickPay reform, announced in September 2011, accelerated payments from the federal government to a subset of small business contractors in the U.S., shrinking the payment period from 30 days to 15 days – thus accelerating $64 billion in annual federal contract value.

Federal government procurement amounts to 4 percent of U.S. gross domestic product and includes $100 billion in goods and services purchased directly from small businesses, spanning virtually every county and industry in the U.S. In the past, government contracts required payment one to two months following the approval of an invoice, with the result that these small businesses were effectively lending to the government – and often while doing so, they had to simultaneously borrow from banks to finance their payroll and working capital.

Our research shows that even small improvements in cash collection can have large direct effects on hiring due to the multiplier effect of working capital. On average, each accelerated dollar of payment led to an almost 10 cent increase in payroll, with two-thirds of the increase coming from new hires and the balance from increased earnings per worker. Collectively, the new policy – which accelerated $64 billion in payments – increased annual payroll by $6 billion and created just over 75,000 jobs in the three years following the reform.

To give an example, take a business selling $1 million throughout the year to its customers and being paid 30 days after delivering its product. It therefore has to finance 30 days’ worth of sales at any given time (or 8 percent of its annual sales). As a result, it constantly has about $80,000 in cash tied up in accounts receivable.

A shift in the payment regime from 30 days to 15 days means that the firm has to finance only 15 days of sales, or $40,000. And that would in turn help it eventually sustain $2 million in annual sales and double in size.

Holding back growth

These findings confirm the widely shared belief among policymakers and business owners that long payment terms hold back small business growth.

They also raise the question as to why the economy relies so much on trade credit if it costs so much in terms of jobs, and whether other policies might be undertaken to reduce it. An interesting follow-up policy to QuickPay was SupplierPay. In that program, over 40 companies including Apple, AT&T, CVS, Johnson & Johnson and Toyota pledged to pay their small suppliers faster or enable a financing solution that helps them access working capital at a lower cost.

It is likely that more information on customers’ quality and speed of payments would allow suppliers to choose whether to work with businesses that pay more slowly. So following a “name and shame” logic, companies might feel they have to accelerate payments not to be perceived as bad customers.

The broader impact

Would it make sense to sustain and extend this policy?

An interesting aspect of our analysis is that the effect of QuickPay depends on local labor market conditions. It was most pronounced in areas with high unemployment rates when it was introduced. Elsewhere job creation was limited.

The reason for this is that helping small businesses grow gives them an advantage over other companies operating locally. By hiring more, these small business contractors make it harder for others to do so. Unless there is unemployment, this crowding-out effect offsets the employment gains of the policy.

As such, such a policy will be effective in stimulating total employment only in areas or times of high unemployment.

Author: Jean-Noel Barrot, Assistant Professor of Finance, MIT Sloan School of Management

SMEs Unlikely To Switch Banks

As we continue our series on the results of our SME surveys, we look at bank switching behaviour. Satisfaction levels with their banks are pretty bad, but there is something weird here, because whilst three-quarters of SME’s say they would consider switching banks, in practice they rarely do.

More SME’s are dissatisfied with their current banks. We see significant polarisation, with some feeling completely satisfied, and others completely dissatisfied.

switching-nov-16-satisfactionAn analysis at the segment level reveals that more established, larger businesses tend to be more satisfied, whilst smaller and growing businesses are generally less satisfied. Those borrowing are less satisfied.

switching-nov-16-seg-sat The average number of bank products varies across the SME base.

switching-nov-16-productsHowever, on a segmented basis, larger businesses tend to have a greater number of products.

switching-nov-16-seg-prodAround three quarters of SME’s said they would consider switching.

switching-nov-16However, from the time with bank data, we see that most stick with their existing relationships.

switching-nov-16-time Our analysis suggests three reasons for this. First, many perceive little or no differentiation between banks, so there is no point in switching. Second, their current bank has provided facilities which make it hard to switch, including secured loans, credit cards and payrole services. Third, some have sought to switch, but have been unable to replicate the current facilities they have from their current bank.

More generally, because time is money, many SME’s experience inertia, because they are focusing on their business, not their banking.


SME Business Confidence – A Curate’s Egg

As we continue our journey across the latest SME survey data, today we look at the latest business confidence scores. We ask a series of questions about hiring plans, sales expectations, profit margin, borrowing plans and other factors, and distill this into a relative numeric score. Essentially, the higher the score, the more confident the business. This is important because confidence is directly linked with business investment and jobs creation.

We find that generally businesses who are formed as a company are more confident compared with those who are not; and those willing to borrow are more confident than those who do not.

confidence-nov-16-structureWe also found that businesses with smaller turnover were significantly less confident, compared with those with larger volumes. This is a problem because there are many more business with smaller than larger turnover (note the yellow line – distribution of businesses – is a log scale).

confidence-nov-16-turnoverScore by industry varies, with education and training the most positive and mining the least positive.

confidence-nov-16-industryOn a state basis, VIC and NSW businesses are the most confident, whilst those in NT and WA are the least positive.

confidence-nov-16-stateWe also find considerable regional variations, with those closer to a CBD more positive, whilst those in regional and remote areas are less positive.

confidence-nov-16-zoneFinally, we look across our SME segments, we find that career switching start-ups are the least confident, whilst large established firms are most confident.

confidence-nov-16So, if you are a small business based in regional WA, you are most likely to be feeling less confident about the future of your business, compared with a large established business in VIC or NSW CBD. A Curate’s egg indeed!

Next time we look at SME’s banking relationships.

SME’s Are More Connected Than Ever

We continue our series on the results from our latest SME surveys. Today we look at the digital trends of SME’s. On average, around 13% of firms are digital luddites – meaning they hardly use digital at all, but the rest are digitally aligned. This means they prefer using a mobile device, are likely to be using social media, and to use cloud based services.

We separate these digitally aligned firms into those who are natives – meaning they have grown up digital, and those who have migrated to digital. Natives have a much higher propensity to adopt new technology, and are much more interested in Fintech offerings.

Things get interesting when we look at the segments.

nov-16-technoThis is reflected in their preferred channel for banking. More than ever are now wanting their banking delivered via apps, or smart phone. Bank branches are important, for a minority, mainly because of the need to handle cash. The channel mix does vary by segment.

nov-16-techno-channelMany firms are now connected 24×7, but this does vary by segment. Around 20% are hardly online at all. This highlights the need to bankers to have an appropriate set of channel strategies for their SME customers. Many do not.

nov-16-techno-timeMore are using smart devices as their main device. Some still use personal computers.

nov-16-techno-deviceAwareness of cloud delivered services is increasing, and once again we see some interesting variations across the segments.  Digital natives are most comfortable.

nov-16-techno-cloudFinally, awareness of Fintech alternatives to the banks continues to grow. Again, digital natives are most comfortable and most likely to consider applying for funds from non-conventional lenders.

nov-16-techno-fintech   Next time we will look at business confidence, which varies across the segments, and across states.



SME’s Are In A Cash Flow Squeeze

In the second of our latest posts using data from our SME surveys, we look at how and why firms borrow.

Some firms will simply not use credit at all, and we find that on a segmented basis, there are significant variations. For example, almost all Cash-Strapped Sole Traders will be seeking credit, whilst only 30% of Career Switching Start-Ups will borrow. Most banks do not segment their business effectively, so do not understand these important differences. There are also very different credit risk and default profiles.

sme-nov-2016-credit-useFor those who will borrow, there are many reasons why they need funds. However, the number one need is for working capital.

sme-nov-2016-main-need Within working capital the main reason is delayed payments (43%).

sme-nov-2016-wc-needThis is because the average number of  debtor days continues to blow out. More than 50% of payments are now being settled beyond 50 days. Large firms and government departments are the worse payers.

sme-nov-2016-debtor-daysFirms in WA and TAS have the longest wait times for payment.

sme-nov-2016-dd-statesThere are also some variations between industries.

debtor-daysFinally, we see that the average loan and card balance varies wildly across the segments. Note this chart shows the value on a log scale.

sme-nov-2016-balances We do not think the underwriting standards in many of the banks take sufficient account of the variations between firms. As a result, many are not able to gain the funds they need, whilst others are regarded as more risky than they really are. Time for better segmentation.

Next time we look at how firms are using technology, and how they view Fintech alternatives.