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.

SME’s Still Under The Gun

Today we start a series on the results from our latest SME surveys. We have data from our statistically representative cross sections of 26,000 businesses, from small part-time businesses up to well established firms. This data feeds our SME reports, and we are working on the next edition, though the 2015 version is still available and is available on demand. This is a top-level summary of our findings, the detailed analysis is available for our paying clients.

We begin today with some basic facts about the sector, before we look at their levels of confidence, use of technology, borrowing needs and propensity; and hiring plans. We find that many businesses continue to struggle with tight cash-flows and are unable or unwilling to borrow more to help grow their businesses. Debtor days are increasing for many, as larger firms, and government departments are settling their invoices on more extended terms. Switching between banks is still relatively rare.

The state of SME’s are important because around 5 million households are reliant in income from them, and when they fire, they can become a significant growth engine. We will also, later, discuss the state by state variations, which are significant.

So to begin. There are more than 2.2 million small and medium  businesses. Many are located in the main urban centres, but there is also a smattering across the regions as well.

sme-nov-2016-countWhen we look across an industry classification, we see that the largest segment of the market is construction, then technical, and then real estate and rentals. Property and construction related activity provides employment to more than one third of businesses, directly or indirectly.

sme-nov-2016-industryBorrowing is strongest in the construction sector, whether we look at secured and unsecured loans, or credit card debt (which may be either on a business card, or a personal credit card).

sme-nov-2016-borrowing At this point we introduce our SME segmentation model. Segmentation is essential when looking at the SME sector, because the businesses are so varied. Our model takes account of a number of elements, including purpose of the business, length of time trading, history of the principle and number of employees. Here is a brief summary.

Hobbyists are running part-time businesses, for example trading on eBay, doing a few hours in the “gig” economy, or doing it just for fun.

Career Switching Start-ups are new businesses created by people who, either from choice, or redundancy have decided to start their own business.

Cold Start-ups are new businesses, starting from scratch, with limited experience and funds.

Cash-strapped Sole Traders are businesses who have been trading for some time, but are finding it difficult to maintain a balance of selling and delivering to customers. Many are in the construction sector.

Stable Contractors are businesses who have been trading for longer and are in a more stable condition. Many will be sole-traders.

Established Service Contractors are more resilient, and often employing business, with a track record, and established customer base.

Professional Independents are self-employed qualified individuals, working in a number of professions, from medicine, law, financial services to vets.

Growing Business, are on the move, seeking to expand and extend. They are mainly employing businesses.

Business in Transition are those seeking to change, from for example, sole trader to a company, or commence international trading.

Mature Steady State businesses are well established firms, where the focus is not on growth, but on keeping the business running efficiently.

Finally, Large Established Firms are those with large number of employees, a successful track record of trading, and an established brand.

The relative distribution across these segments is shown below.  This highlights the effectiveness of the segmentation.

sme-nov-2016-segsWe do not use turnover as a primary segmentation element, though turnover tends to increase as we move from simple part-time businesses to more complex trading entities.

sme-nov-2016-to

The time trading has a significant impact on the segmentation, as you might expect.

sme-nov-2016-trading-time

We also find the age of the principal varies across the segments.

sme-nov-2016-ageSo having painted an overall picture, next time we will look at business confidence, then borrowing propensity.

How Big Is The SME Fintech Unsecured Lending Market?

Given the rise in the number of Fintechs targetting the SME unsecured lending sector, it is timely to consider the potential addressable size of the market in Australia. To do that we have taken data from the Digital Finance Analytics SME survey of 26,000 businesses, and used this data to estimate the current size of the market. The latest data is from August 2016.

Piggy-BusinessFirst, we need to focus in on smaller SME’s, so we set a turnover ceiling of $500k. In fact though there are more than 1 million businesses in this category, many SME’s have much smaller turnovers than that. Then we remove from the analysis secured loans (either against property or other assets), leases, factoring and credit card debt. This gives us a read of the level of unsecured debt. We also excluded businesses who prefer not to borrow at all.

So, we estimate that currently, the stock of unsecured loans to these small businesses is around $8.2 billion.  Of this, $5.3 billion would show up as a business loan, either as an overdraft, structured loan or term loan in the RBA data. The rest is classified as personal debt, meaning it is a personal loan or overdraft, but it will still be used for business purposes. So, $2.9 billion relates to loans which would be classified as personal finance in the RBA data. This also highlights the significant “twilight zone” between business and personal finances.

Next, we need to estimate the annual flow of these loans, and also overlay those businesses with the potential to access a Fintech loan. At very least they need to be comfortable with using online services, and tools. So we excluded the “digital luddites” and those not tech savvy.

We estimate that $3.6 billion of unsecured lending was written by lenders, of all sorts, to our target businesses, in the past 12 months. Of this $2.1 billion was a business loan, and $1.5 billion was a personal loan. This includes refinancing of existing loans, and new loans.

Most Fintech SME lenders will only lend to a business, with an ABN. So, we should discount the $1.5 billion of personal loans. That leaves a current annual addressable market of around $2.1 billion. We also expect this to grow strongly in coming years.

We are already seeing a strong trend in the growing awareness of Fintech among businesses. The joint DFA and Moula Disruption Index is tracking this momentum.

Dis-July-2016Increased digital penetration, and greater awareness of Fintech alternatives will increase the addressable market quite considerably. In addition, new lenders may offer loans to businesses which today cannot obtain credit.

So, in conclusion, despite the relatively early history of the sector, there is an addressable market which is significant, and interesting and north of $2 billion annually. Whilst the market is small compared with the $40 billion consumer credit card industry or the $140 billion total consumer credit market, it is set to grow.

Finally, it is also worth considering our post from yesterday, which looked at some Fintechs charging very high rates of interest. Will increased competition drive rates lower and create a still larger market?

Banking red tape costs Aussie SMEs $7 billion a year – Tyro

BANKING red tape is robbing more than 880,000 of Australia’s two million small and medium sized businesses of four weeks’ productive work time a year, costing the national economy almost $7 billion annually, new research has found.

This equates to an extra 20 working days a year – or the entire annual holidays of the average employee. 

Tyro’s Exploring banking inefficiencies for SMEs report has found that 44 per cent of Australian SMEs, or 880,000 businesses, spend more than three hours every week checking, entering, paying and reconciling data, costing each business an average of $7,800 a year.

The findings of the survey reveal the seven major pain points in terms of productivity when it comes to online business banking and related activities.

SME-PaiinpointsTyro’s report also found that:

  • 700,000 businesses, or 35% of SMEs, believe their bank could be doing a better job.
  • One million, or 50%, of SME owner/operators are doing their own bookkeeping.
  • 400,000, or 20%, of SME owner/operators don’t use any form of accounting software.

“Large companies, with more than 200 employees, make up only 0.3% of businesses operating in Australia,” Tyro CEO Jost Stollmann said today. “By comparison, small and medium sized businesses are the creative and innovative heart of the Australian economy, generating more jobs than any other sector. “But SMEs are drowning under the burden of inefficient online business banking processes, that are robbing them of three hours a week, or 20 days a year.

“This means SMEs have to work a 13-month year, or give up the equivalent of four weeks’ annual holiday to compensate for banking inefficiencies.” 

The findings explain why a staggering 700,000 SMEs are unhappy with their business bank’s performance. Mr Stollmann said efficient online banking was critical to the success of SMEs and for a large proportion of Australian businesses their bank was letting them down. “Banks need to try harder to reduce the burden on Australian businesses,” he said. “It is clear that business banking requires a rethink. It needs to be mobile, embedded into business and accounting software and fully automated. “The winners in the business banking of the future will marry deep technology and banking know-how.”

Despite SMEs playing a critical role in the Australian economy, their contribution to GDP has slowed since 2012. 

Mr Stollmann said the priority was to establish what the major pain points were for the industry and help SMEs drive future growth. 

Billions of dollars have been spent by the private and public sector to assist SMEs, particularly around improving workplace participation. 

However, very little has been done to address the issues of access to capital or business and banking improvement processes. 

Mr Stollmann said SME banking was an industry in transition, and the major providers needed to make it easier for customers to do business. 

“Australia’s small and medium sized businesses are developing into the most attractive banking customers in the country. 

“From a market that was once considered very niche and challenging to serve, SMEs have now become a strategic target for banks,” he said. 

“This flows on from the 2008 financial crisis, when banks began to shift their focus away from large corporates in an effort to seek high yields in a low interest rate environment. 

“Banks now see SMEs as core to their business. 

“Australia should be looking at action to improve SME productivity, in recognition of the changing terms of trade and resources decline. We should help SMEs operate more efficiently.” 

Commonwealth Bank of Australia CEO Ian Narev acknowledged this recently when he said CBA had to innovate or die. 

“If we don’t innovate successfully, we’re toast,” Mr Narev told free-market think tank The Centre for Independent Studies in June. 

“Not we’ll lose a bit of profit, we’ll lose a few customers — we’re toast. And I’m talking over a decade, not over six months, but it is an existential imperative for us to innovate.”

Long pay times sinking contractors

The DFA SME survey underscores that payment terms for many businesses continues to extend, creating real headaches in terms of cash flow, profitability and sustainability.

Using date from our latest results, from 26,000 business owners, we see that working capital is the main reason to borrow.

SME-DD-3The main driver of working capital is delayed payments. There are significant variations by industry, with those in the transport sector the worst hit.

SME-DD-2Nearly half of payments are received between 50 and 60 days after billing. Over 60 days includes some payments to more than 120 days due.

SME-DD-1Businesses told us that they are getting squeezed harder as larger companies and government departments hold up their payments for longer.  You can read the last SME report, released in late 2015. The next edition will be released shortly.

We are not the only ones highlighting this issue.  According to The West Australian today:

Up to eight contracting businesses are going under each week, an equipment hire industry figure says, with late payment by clients the main cause.

Sally McPherson, chief executive of online equipment broker iSeekplant, called on governments to crack down on ballooning payment periods.

Ms McPherson said two to three members of iSeekplant had failed per week in WA over the past six weeks. Information about the other collapses came from the broker’s State office.

The victims ranged from owner-operator outfits in construction and mining to businesses with about 150 machines.

Many were mid-market players with 20 to 40 trucks, loaders and excavators.

Ms McPherson said some collapsed operators were re-emerging as new companies after escaping debts.

“We’re seeing definitely the worst conditions in the plant and equipment market for 30 years,” she said.

She blamed client payment periods of 90 to 120 days.

“It’s the number one factor,” Ms McPherson said. “Big companies are leaning on these tiny enterprises for their cash flow.

“The margins on hire in WA, if at all profitable, are razor-thin. These companies go under just purely because of cash flow. The bank doesn’t ever give them a 120-day break on their payments. It’s not fair.”

Ms McPherson said small contractors agreed to such contract terms because of the larger companies called the shots.

“Government should step in and stipulate what’s a fair term considering that it’s government money,” she said.

 

SME Business Confidence On The Rise – NAB

The latest NAB Quarterly SME Survey, to June 2016, suggests the non-mining recovery is broadening to include smaller businesses, with SME business conditions highest in six years, and confidence above long-term average despite some increased pressure on cash flow, and falling forward orders.

Business conditions for SMEs gained further traction in Q2, rising by 2 points to +6 index points, a level not seen since 2010 and comfortably above the long-run average of +4. It is especially encouraging that low and mid-tier firms reported notable improvements in conditions and confidence in the quarter. In particular, low-tier firms reported positive business conditions for the first time in 2 years.

NAB-SME-Jun-2016---1All three components of business conditions rose in the quarter. Trading and profitability conditions surged ahead, reaching levels not seen since 2009. Employment conditions however remain lacklustre. The optics of conditions by firm size were also quite encouraging, with all size categories reporting positive results for trading and profitability conditions, although demand for labour by low-tier firms remains soft.

Meanwhile, SME business confidence rebounded to +5, above the long-term average of +2 index points and more than reversing the fall in the previous quarter. It is worth pointing out that the survey was conducted prior to the Brexit decision and federal election and therefore does not reflect the possible shifts in sentiment due to these political events. However, our latest monthly NAB Business survey for June, which was polled during Brexit (but before the election), did not show an adverse impact on confidence.

NAB-SME-Jun-2016---2In level terms, all SME industries except for construction reported positive business conditions in Q2. The health sector outperformed other industries in the quarter, followed closely by business services, while retail was the weakest after construction. Meanwhile, there has been more evidence of late that the wholesale sector is experiencing a recovery in its business conditions.

NAB-SME-Jun-2016---3All states, except for WA, reported better business conditions in Q2, with QLD showing the biggest improvement again (up 10 points to +11). NSW and VIC continued to outperform, while WA has lagged further behind the national average. All states were more confident in the quarter, with VIC being the standout, while WA was the least confident and the only state to report negative confidence.

Leading indicators were stronger in the quarter as well, with capacity utilisation rising to levels last seen in 2011, while capex reached the highest level since 2007. Overall, SME input price indicators point to relatively contained price pressures, while easing price growth for retailers is consistent with the subdued inflation outlook.