Others

Internal Financing

A major source of funds is through proper management of internal cash flow, to release funds that are 'locked up' within the business operations. In theory, this does not result in absolute increases in cash balances. Rather, internal financing strategies promote better utilization of cash. Three strategies that are discussed here are: (1) Working Capital Management, (2) Deposit Management and (3) Commercial Practices Management.

Working Capital Management

Holding excessive balances in current assets such as inventories and account receivables results in cash being 'locked-up' in a company's Balance Sheet. For instance, by stocking up on inventories, companies do not only reduce the amount of cash available for other activities such as capital expenditure, they also increase storage expenses and risk costly write-downs from stock obsolescence. SMEs should adopt inventory management policies and processes to reduce the need to hold inventories.

Trade Receivables (debtors) is another significant investment in working capital, which can potentially be converted to positive cash flows and re-directed into other value-creating activities. Strategies include tightening of credit allowance, imposing interest charges on late payments, giving cash discounts for early payments, and sending timely Statements of Accounts to customers. Other preventive measures include periodic assessments of existing customer account balances (i.e. aging accounts), conducting proper credit evaluations before accepting new customers, and 'softer' approaches such as obtaining information from credit bureaus or even other industry players.

Deposits Management

Another area where the business can increase the availability of cash flow for investing activities is the management of prepayments and deposits. Businesses must bear in mind that deposits are necessary only as a mitigation strategy against counter party default risk. For example, when SMEs bid successfully for government tenders, a security deposit must be placed with the government agency in the range of 0-5%. In order not to lock up its cash in such deposits, SMEs can obtain a banker's guarantee as a substitute security instrument. This, however, may result in the lines of credit of the SME being reduced. Another alternative, allowed by the Ministry of Finance (MOF) for government related projects, is the issuance of performance insurance bonds as security deposits instead.

Even with all the above measures that SME can take to reduce cash and credit lines from being locked up in deposits and prepayments, businesses (in particular SMEs) cannot overlook the fundamentals. In order to reduce the amount of security deposits required,

SMEs must build up the trust and confidence of their trading and business partners. This includes establishing a sound name through business best practices such as timely execution of contracts, prompt payments for goods and services, and conduct of other areas of business such as transparency in financial reporting.

Commercial Practices Management

Generally, SMEs are often disadvantaged when it comes to debt collection, especially from debtors with strong bargaining powers such as the larger organisations. Hence, whilst business development is important, it is also critical that SMEs manage their commercial terms and conditions to ensure more timely collections. To avoid resistance from customers, these terms of business practices should be mutually accepted at the initiation of the business relationship, and revisited regularly to assess adherence to the agreed policies. At the same time, SMEs should also make their employees (including sales staff) accountable for collecting trade receivables on time.

Factoring

What is it?

Factoring is a unique way of obtaining financing and differs greatly from the other sources. It involves the conversion of accounts receivables into cash for the business, through an institution (usually a financial institution) known as a factor.

How does it work?

The company concerned negotiates a deal with the factor to 'trade' its accounts receivables (or billed invoices) for instant cash. In the process, the factor will retain 10% (or any other amount as negotiated, depending on the risk of the outstanding receivables) of the gross value of the invoices value as service fee. There are basically three types of factoring services available:

Who qualifies for it?

The main criterion for factoring is the quality of the accounts receivables. It would be very difficult to negotiate a contract with a factor if the company has been dealing with customers of questionable credit worthiness. Along the same line, factors are more likely to accept a contract if there are formally established supplier-customer relationships between the company and its customers, instead of informal agreements such as complex contra-balances and consignment basis sales.

A crucial factor to consider is the relationship that the company has with the customer. If the company is dependent on a few customers, then factoring may not be a good option, as it undermines the relationship between the two parties.

What are the advantages and disadvantages?

The advantages and disadvantages of obtaining financing through factoring of accounts receivables are detailed below.

Advantages

• Reduced credit risks from uncollectable debts
• Reduced need to dedicate time and resources to maintaining customer accounts balances
• Company can sell more confidently with open accounts terms of up to 90 days, thus offering more competitive credit lines to customers and possibly increasing sales
• Invoice discounting services offer confidentiality to the company (i.e. the customers will not know that the company is using a factoring service)

Disadvantages

• Fess paid to the factor out of invoice value. May be up to 15% of invoice value, depending on the size of the invoices, ease of collection (local versus overseas), and credit worthiness of the debtors (i.e. credit risk).
• Jeopardized relationships with customers who feel 'betrayed'
• Employees do not feel accountable for collections, and hence do not spend adequate time on customer evaluations. The quality of the customers' portfolio may deteriorate over time as a result.
• Lost opportunities to interact with customers to understand their needs and interests

Financial Advisory Services

Financial Restructuring (debt and equity)

In the business world, economic downturns and corporate failures are inevitable. Corporate recovery, to achieve profitability or salvaging viable assets, involves a broad range of options. The process will involve all the key stakeholders of the company concerned: owners, managers, creditors, shareholders and banks.

There are many firms offering such services in Singapore, such as the major accounting firms and some boutique financial advisory firms. These firms can assist in finding an appropriate solution for the distressed organization. Such situations generally require expertise from both financial and legal advisors. Negotiations will be undertaken with the company's key stakeholders.

Enterprise valuations

SMEs may at one point require an independent assessment of its enterprise value. Valuations are carried out for many different reasons. The need could arise if creditors or investors require a third party valuation of the firm as a whole before approving a loan or making an investment decision. Most of the financial institutions and the major accounting firms offer such solutions to organizations.

Capital raising, private placements and IPO

In order to grow and expand business operations, SMEs will need to raise funds to purchase more stocks, invest in R&D, and acquire more productive assets. However, given their relative lack of financial track records, it may sometimes be difficult to obtain viable sources of financing. In addition, firms that are considering listing on the stock exchange have to grapple with a wide range of issues, from meeting compliance needs to distributing the stocks to potential subscribers.

There are many corporate finance advisory firms in Singapore that can help SMEs in mitigating the problems associated with raising capital, either by helping the company draft a solid business plan, by acting as a middle man between the company and private investors, or simply by advising the company through the IPO process.