SME Lending – Financial Drivers
For a Business Finance Professional, the ability to understand financial data is essential. The language for business is finance. Business goals and targets are set in financial terms, and success is generally measured in financial outcomes. Among the skills required to understand and provide advice to SMEs on their business, is the understanding and analysis of financial data along with the ability to present information in the form of financial reports. For lenders, the quality, details and insights from these reports are fundamental to their decision making.
When reviewing financial data, there are many key figures for Business Finance Professionals to consider. They need to know which numbers are the critical ones to analyse and what are the most important factors. Cash flow is critical to business success, so focusing on what drives business cash flow is an excellent start.
There are seven key financial drivers. Information from each of the key drivers is invaluable in assisting SME clients in identifying the areas they need to address to achieve improved cash flow and make informed strategic business decisions.
The three drivers that relate to cash flow are:
Debtor days: The faster a customer pays, the better the use of cash! If the number of days it is taking debtors to pay is growing quicker than sales, and your credit terms remain the same, you could face a cash flow problem.
Stock/Work in Progress days: Keeping track of the cost of holding stock helps to monitor potential overstocking or buying a particular stock that is not selling.
Creditor days: If you are paying suppliers faster than customers are paying you, it can cause a squeeze on cash. The longer you can negotiate, the better the use of your cash.
The other four drivers relate to business profitability.
Price: Increasing or decreasing the price of goods has a direct influence on cash. Monitoring margins helps you spot quickly if profit margins are reducing and act accordingly.
Sales: Sometimes, selling more can create cash flow issues because the business has to fund that sale, often well before the customer pays.
Cost of Goods Sold: Negotiating or restructuring the cost of your goods — for example, buying in bulk or reducing waste — can have real cash impact.
Overheads: These monthly expenses maybe for the same items, however, can vary from month to month, so they require monitoring of actual versus budget to keep a handle on operating costs.
Unfortunately, it is common for SMEs to only concentrate on one of these drivers – Sales. However, it is the cash flow drivers (debtor days, creditor days and stock/work in progress days) that are more impactful, and if neglected, can be troublesome for a SME.
For example, sales may be steady, but if the time it is taking to receive the cash increases, profitability will be down.
The Cash Conversion Cycle
The period between the first expenditure on a product or service and when money is received for that product or service is the cash conversion cycle. The faster the cycle turns, the faster a SMEs trading activity converts into available cash.
All seven business drivers have an influence on the cycle, and a Business Finance Professional can work with their SME client to monitor them and shorten the cycle or funding period. Introducing relatively small changes to financial management practices can result in significant improvements to cash flow. And by doing so, the SME business is more viable and stable, and the ability to access finance when required is heightened.
Once Business Finance Professionals can analyse the seven financial drivers and understand the cash conversion cycle of a business, they are well-positioned to have high-level discussions with their clients about future growth and the role lending and finance can have.
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.