SME Lending - Key Metrics
With very few exceptions, small business owners don’t go into business because they are excited about keeping the books and accounts and pouring over the numbers. They are passionate or see great opportunity in their journey as an SME. And perhaps, unfortunately, many think the rest will take care of itself.
Financial metrics are critical for the ongoing success and longevity of every small to medium-sized business.
Those that do recognise this importance and take the time to step back and analyse the figures are to be commended. However, the question is, are they getting the full picture?
Without the assistance of an accountant or Business Finance Professional they may only have a limited understanding of how their business is positioned.
In conjunction with a business adviser, analysing the key metrics provides three overarching benefits for SME owners.
Running the business – making decisions based on facts and figures and not just ‘gut feel.’
Passing the sleep test – knowing that the business is profitable and sustainable as opposed to always wondering if it’s on the slow decline to bankruptcy.
Instilling confidence – owners that have a good understanding of their business exude confidence to those around them, including lenders who are appraising finance applications.
As a Business Finance Professional, you can add tremendous value and worth to SME owners by helping with the analysis of their key metrics. These may be precursors to lending and financing scenarios or simply as sound business practices.
The following are five of the more important small business metrics. By themselves, they are reasonably basic. However, the way they are reviewed and analysed can make the difference.
Income (or sales) is the obvious lifeblood of any business. Without it, employees don’t get paid, equipment and stock can’t be purchased, and suppliers won’t deliver. It is the first metric that requires attention and focus. It should be carefully projected and monitored almost on a daily basis. Historical income comparisons can tell you how your business is tracking compared to last week, month, quarter or year.
From a lenders’ perspective, it’s also one of the first things they evaluate. Does the business have the income to make regular payments against a loan? Without steady and consistent revenue, debt servicing ability is questionable.
Next, a SME needs to know the cost of doing business. The difference between business expenses and income determines whether the business is profitable and able to keep the doors open. Profitability is the ultimate goal for any business.
Whilst some businesses look for investor capital to cover their expenses (typically in the start-up phase), at the end of the day SMEs rely on selling their goods or services for more than it costs to make or supply them.
Breaking expenses into different categories can be extremely beneficial as part of financial analysis. This can tell you, as the Business Finance Professional and the business owner, the areas to look at for cost-cutting and savings.
3. Cash Flow
Whilst “Cash maybe King”, it’s more than having money in the business bank account at the end of the month. The Cash Flow metric compares the business’ assets and liabilities (dividing liabilities into assets). A healthy cash flow metric is a ratio of 2:1 - two times as many assets as liabilities. Although most businesses struggle to achieve and maintain this level. If the ratio is less than 1:1 it can indicate that a business doesn’t have enough cash flow to maintain operations.
The cash flow metric is an important consideration for SME lenders. Loan repayments are defined as liabilities and can, therefore, reduce a business’ cash flow metric to below 1:1, if a loan is approved. This could suggest to a lender the business is attempting to borrow its way out of trouble and would be reticent to approve a loan. Armed with this knowledge, Business Finance Professionals can work with their SME clients and ‘sure-up’ their cash flow metric before applying for finance.
4. Accounts Receivable Ageing
This is the time it takes a business’ customers to pay their invoices. If the business offers 14-day terms, what percentage of them pay within the 14 days, and how many of them pay in 28 days or even 60 days?
It is an important metric that can’t be ignored, as late payments start to eat into profitability because of the impact they have on cash flow. In addition, the longer an invoice is outstanding, the more likely it is that it won’t be paid at all!
Instead of putting it down to bad luck, astute businesses are proactive with their accounts receivable, providing constant reminders to late-paying customers and incentivising early payments by offering discounts. Such discounts can be financially advantageous for businesses as they have earlier access to income to use to generate more revenue to the business.
5. Accounts Payable Ageing
This is the average number of days it takes a business to pay its financial obligations. Those businesses with regular income, controlled expenses, healthy cash flow and well-managed accounts receivable are positioned to keep accounts payable up to date and not fall into arrears.
There can be a financial advantage of discounts through early payment terms offered by suppliers. However, the single most important reason for maintaining current accounts payable is a business’ credit rating. By demonstrating a commitment to meeting its business credit obligations, when it comes time to borrow, a business will have increased options.
Each SME a Business Finance Professional works with will be different, and using these five metrics is a good starting point. There may be other metrics that apply, or it may be that delving deeper into some of these basics can provide enhanced understanding. As mentioned, breaking down income into different streams or categorising expenses can lead to greater business control.
With a business analysis approach to working with clients, Business Finance Professionals are moving their services from a transactional relationship to a consultative one. A relationship that helps your SME clients grow their businesses.
In conjunction with industry experts, elevateB has developed a self-paced, online, interactive Business Finance Certification. This program will provide you with the knowledge and skills required to become a successful Business Finance Professional and work in the SME space. In addition, it provides strategies and soft skills to assist you to better market and deliver your existing and new-found client offerings.
For more information on the Business Finance Certification, click here.