Small businesses rarely have more than a few weeks of cash on hand, yet many have considerable accounts receivable, often representing 60 to 90 days of sales that are yet to be collected from their customers. A small business with $4 million in annual sales and terms of 90 days has nearly $1 million trapped in accounts receivable. Moreover, with the pandemic, payment terms are extending rapidly as even the largest companies in the world look for ways to increase cash on their balance sheets.
Covid-19 impact on Bangladesh's SME landscape by Lightcastle Partners
In Bangladesh alone, SMEs make up 90% of all industrial enterprises, contribute to over one-third of industrial value added to GDP and provide employment to 4 out of 5 industrial workers. These SMEs are owed billions from their customers, many of which are large companies.
This was our first question upon realising the extent of the problem that SMEs face. In the first few months of 2020, Covid-19 had slowly started immobilising the international and domestic trade mechanism and we could foresee the problem increasing for SMEs. Over the last 3 months, access to working capital has become increasingly difficult and not mention expensive. Banks are inherently sceptical when lending to smaller enterprises given the higher risk of non-payment so a fundamentally different approach was needed if we were to mitigate the risk and streamline access to capital for these smaller firms.
To put in simply, we understood the need to eliminate credit underwriting, generating loan documents and approval processes for hundreds of thousands of businesses which are already vastly overwhelming traditional finance channels. Instead of borrowing, businesses could simply request to be paid more rapidly by their large company customers, something that likely is much preferred over borrowing by all small business owners. Do this at scale and we can create billions of dollars in immediate relief for the country’s small and mid-sized businesses without causing them to have to borrow a penny.
Our Dynamic Discounting platform matches accounts payable and accounts receivable, and lets suppliers order their cash payment earlier from their customers at rates they name. No borrowing, no advance rates, collateral or personal guaranties; just earlier payment (up to 99% of invoice value). This not only presents opportunities for SME suppliers but also generates significant cost savings for their corporate buyers. COGS reduction results in better margins and a healthier bottom line. Furthermore, as interest rates fall, corporates can achieve much higher returns (up-to 40* APR) on their available liquidity by participating in early payment programs. A simple 2% discount on an invoice due in 30 days translates to 24% APR, leaps and bounds above market returns. A true win-win!
A common question we get from visitors to our website is what if firms don’t have the liquidity to issue early payments and capture discounts? Well, quite simply, if liquidity is tight, Dynamic Discounting can be switched off with the click of a button, corporates are in control of the program and only operate it if it serves their purpose. Also, we realise that liquidity situations may change over time and have separate solutions (Payment extension & Supplier Financing) for corporates in these situations.
Banks and financial institutions are facing historic challenges with interest rate drops and rising default rates, especially in the SME finance sector. City bank, a leading local bank has reported SME financing non-payments have exponentially surged from a mere 2.5% to 81% since lockdowns began (The Daily Star). According to Mr. Selim RF Hussain, CEO of Brac Bank, in January and February, the cost-to-income ratio of Brac Bank for SMEs was 85 percent, which means the bank spent TK0.85 for earning TK1. Its cost-to-income ratio is now 130 perfect after enforcement of the lending rate cap, making the bank’s TK16,000 crore SME portfolio, a loss making venture. Furthermore, he says it is impossible to do this business at the 9 percent interest rate (The business standard)
Mitigating risks of lending to SMEs in such uncertain business environment requires a fundamental redesign of the lending process. We came up with anchoring as a possible solution to mitigate risk. It allows suppliers to anchor their risk of borrowing on to their larger corporate buyers (usually better rated) as cash advances are made on receivables from larger buyers instead of their own credit worthiness. Receivables financing / invoice financing is a far safer financing product as the risk of non-payment, although very low, is often not assumed by financiers.
Our Payment Extension platform serves corporate clients that lack the liquidity to make payments or early payments to its suppliers. Covid-19 has had a significant impact on large companies and liquidity issues can be seen across most industries arising from a steep fall in consumer demand and cancellation of export orders amounting to billions. Very often, large firms will delay payments to suppliers when faced with a liquidity crisis. This not only aggravates supplier’s financial position but also causes ripple effects that could disrupt entire supply chains.
Our Supplier Financing module is a digital financing solution which connects corporate buyers, SME suppliers and third party financiers onto a single platform for all financing needs. The solution benefits all parties as It gives suppliers the opportunity to receive a discounted value of their receivables (upto 85% of invoice value), prior to the maturity date, from one or several funders, while the buyer (usually better rated) extends their payment terms and then repays the funder at maturity with zero added cost.