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Dominion Post - Monday September 3 2007

When the wheels fly off small business

The Dominion Post | Monday, 3 September 2007

KEEPING THINGS SWEET: Adrian Owen, of Wellington design studio Sweet Chilli, says his income can be unpredictable. To smooth out his cashflow, he signed up with invoice discounter Interface Financial, which can give him 90 per cent of the face value of a bill the same day.

A cashflow crunch is the big killer of small businesses. One way out of the hole is to sell your invoices. But is the cure worse than the disease? John McCrone reports.

It's the mistake seen time and again. A business is started full of bright hope. Capital is borrowed from the bank, secured against bricks and mortar.

A year later, the business is going great guns. Orders are piling in. Big new customers are saying yes.

The wheels are really spinning. But what this also means is there is likely to be a sudden yawning gap between expenses and profits.

The business is spending ever more money each day, yet the larger customer payments to cover that spending may not arrive till weeks, often months, down the track.

So a trucking firm might have to rush out and buy a second truck to meet that fat new contract. A print shop might have to upgrade its computer systems as a backlog of orders builds.

A year in and a business's first big tax bill is probably also looming. To cap it all, in the hectic rush to get the enterprise off the ground, book-keeping will have taken a back seat, so customer payments are not being chased.

Dun and Bradstreet's latest trade payment figures show that the average account is being paid a fortnight late. It now takes nearly 46 days from invoice – five days longer than in 2004 – for the money to land. For a novice business, it is likely to be even longer.

So come one Monday morning, there is no cash in the kitty. The business owner hurries to the bank for more working capital but the answer is, "Sorry, no can do. You're already mortgaged to the hilt."

With a loud bang, the wheels fly off and yet another perfectly good enterprise ends up in the ditch.

Well, there are options. Some load up the credit cards or find a loan shark. Others beg from family and friends.

But for a small business in cashflow strife, there is another surprisingly undersung escape route: factoring, or invoice discounting.

The idea is simple. If money is due, but perhaps not for a fortnight or a month, you can sell that customer's debt for dollars today.

Adrian Owen, of Wellington design studio Sweet Chilli, heard about invoice discounting through some Auckland business friends. As with a lot of fast-growing creative businesses, his income is lumpy. He deals with some household names, but it can sometimes take a client three months to cough up the dough.

Nothing malicious. Just some firms have better administration or faster sign- off than others.

"Some months you feel like the richest person in Wellington, other months you feel like the poorest," he chuckles. "We can have $30,000 or $40,000 outstanding and we just don't know how long it's going to take to come through."

To smooth out his cashflow, he signed up with invoice discounter Interface Financial, which can give him 90 per cent of the face value of a bill the same day.

Interface, of course, takes its cut. If the customer pays on time, Interface deducts a 4 per cent fee. If payment drags out, the fee rises on a sliding scale, so that payment after 50 days can see 10 per cent sliced off the top.

But Mr Owen says it is worth it. "Basically, it keeps us on an even keel."

The practice has been around many years. But it has been an underused tool in New Zealand, particularly in the small business sector.

David Cooper, general manager of Scottish Pacific Business Finance, one of the longest- established factoring firms, says the idea can have negative connotations. Business owners fear that selling their invoices will suggest they are struggling. Customers could take fright.

Some factoring companies also used to charge penal rates. As lenders of last resort, they were often buying up bad debt rather than good.

"The number of people who still have the misconception that we'll give you 80 per cent and the other 20 per cent is our profit – well mate, I wish it was. It wouldn't take so long till I retire," Mr Cooper says.

There is now enough competition to keep fees sensible. The whole business has evolved.

In Australia, where factoring is far more commonplace, all the big banks are players. But here, only the BNZ has been really active – and it deals mostly with corporate customers.

The newest wrinkle has been the rise of two franchise chains, Interface Financial and Fifo Capital. Mr Cooper says all have somewhat different ways of doing business.

The basic distinctions are whether you prefer to be open or secretive about using a factoring service. And whether you are selling single invoices or using someone to manage all your accounts receivable.

The full service is factoring proper. In effect, says Mr Cooper, you are outsourcing your billing and payment collection. For a small business that does not want to employ a book-keeper, it can be more cost-effective to pay a 1 per cent administration fee to a factoring company. Built into the deal is the ability to draw down cash against any accounts that are due.

It is like having an overdraft facility at the bank, except a factoring company does not expect your home as collateral. "If you draw money, you pay interest," Mr Cooper says. "If you don't draw money, you don't pay interest. Clients enjoy the fact that we can do the collections and there is a lump of money there if they need it."

But factoring also usually means customers can see payments are going through a third party. They can find that confusing, or even alarming.

For this reason, many firms prefer to use straight invoice discounting or "spot factoring". They do the billing themselves and sell only selected debts when there is a cashflow hiccup to cover.

George Rota, of Interface's Wellington office, says some of the deals are large. The other week, he bought a $600,000 invoice off an agricultural exporter.

The lower limit is about $3000 to $5000, though it is usually possible to package together a number of smaller bills.

Factoring companies are, of course, interested in buying only good debt off business owners. "We're not debt collectors," Mr Rota says. "People often don't understand that."

Large debt collection agencies will buy up distressed debt – accounts unpaid for more than 90 days with little hope of recovery – for 5c or 10c in the dollar. But that is quite a different business.

The kind of invoices a business wants to sell to a factoring company are those mostly likely to be settled on time. Otherwise the fees will mount up. And if the debt goes 90 days overdue, it is just going to be passed backed for you to cover.

It is all very organised. But is resorting to factoring actually a good idea?

Andrew Mackenzie, of Shirlaws Business Coaching, says it all depends. There are certain business sectors, like importing or construction, in which invoices are large and payments lumpy.

"If the cost of this form of financing is built into the business model, then it makes sense," he says. And again, it is fine if outsourcing your accounts department is saving you money.

But he would be unhappy if invoice discounting was being used just to paper over poor cash management. Many business owners are too shy or simply too disorganised to make their payment terms clear. They then may not press for payment because they fear it will drive customers away.

However, Mr Mackenzie says customers welcome evidence of professionalism. Or at least they learn which suppliers mean business and which they can string along. "The successful collection of money is just about having a process in place. If a customer goes 30 days, it gets a letter. If it goes 40 days, it should get a phone call and another letter."

And business owners should not be scared to approach customers when they face a cash crunch on a bill. He says that, if a client owes $200,000, they might be happy to pay an instalment early. It might be embarrassing to raise the matter, but it could be a lot cheaper than turning to a factoring company.

So Mr Mackenzie says the aim is still to manage cashflow. But when that chasm opens up in the road ahead, selling invoices can offer a quick fix. "As a one- off, it could well bail your company out."