The alternatives for UK SMEs seeking finance seem to grow almost daily as more and more non-bank lenders enter the arena to secure market share. Some are offering genuinely innovative products, others not so, but what’s for sure is that SMEs have more choice now than ever before.
Many of the smaller companies however are finding it as difficult as ever to source the appropriate finance they need. One answer to the conundrum may be that, even in the dramatically changing world of finance, some key disciplines and criteria remain constant and SMEs often enter the market inadequately prepared.
Irrespective of who is offering the prospect of funding, every lender will still need to assess the quality of the borrower and the likelihood of getting the money back. SMEs need to know and understand the criteria that they will have to satisfy if they are to enjoy a happy outcome to their pursuit of external finance.
The purpose of this article – the first in a series of four – is to equip the would-be borrower with the tools needed as part of an essential ‘financial kit bag’. We will start by discussing the CASHFLOW FORECAST, arguably the most crucial yardstick by which the affordability of credit is usually judged by the prospective lender.
The forecasting process
Many small businesses are surprised when they are asked to provide a cash flow forecast – some regard it as a chore or, worse still, irrelevant. This is a mistake.
Not only should all businesses, whether large or small, produce up-to-date cash flow forecasts for external consumption, they should also do it for themselves as a matter of course. It is a sensible part of good financial housekeeping – more importantly, despite all the tutting and protests, it will tell the lender an enormous amount about the risks they are being asked to take.
Remember, if the proprietors of a business can’t come up with their own cash flow forecast, what chance will an outsider have? It sends out a very poor signal.
Optimistic v Pessimistic v Realistic
The challenge for SMEs is not to give into the temptation to show the lender what they believe they want to see, but to show them the reality. Too often business owners will be over-optimistic, which is perhaps understandable, but there are others who opt to be over-pessimistic in the expectation of out-performing the forecast and impressing the lender. Both are wrong: good lending analysts and underwriters will see through the former straight away and, in the case of the latter, will reject the application on the grounds that the business cannot afford the financing, responsible lending being something every lender must put at the heart of their decision.
The answer, therefore, is to be REALISTIC.
Understand the outputs
In preparing the numbers, remember that this is YOUR forecast – to the lender, it will provide a clear insight into your business. Forecasting doesn’t have to be complicated, but understand your own figures and ask yourself whether they are truly representative. The lender will be testing the forecasts to establish how robust they are and, if they prove to be seriously flawed, the damage will have been done.
If the task is too daunting and it means turning to an outside professional adviser (e.g. an accountant) for help, then so be it. Any cost could prove to be a sensible outlay over the longer term and, if that’s not possible, standard cash flow templates can be accessed via the internet for basic guidance. The important thing is to take the process seriously if you want to avoid disappointment.
This is the first of a four part series. To read the other instalments, visit The Credit4 Financial Kit Bag: Management Accounts and The Credit4 Financial Kit Bag: Business Plan
If you would like to find out more about flexible growth funding from Credit4, give us a call on 020 3637 0570 or read more on our homepage.