Small businesses have always had trouble managing cash flow. An inability to adequately manage funds certainly plays a role in why 90 percent of all startups go kaput.
If a business can survive the pre-seed stage, cash flow management still remains a critical priority, with cash flow found to be a constant struggle for small business owners. Even for larger corporations, research shows, cash flow management is the most commonly cited aspect of a treasurer’s job that keeps them awake at night.
Unfortunately, traditional banks have largely come up short when it comes to offering small businesses the types of financing products they need. It’s not surprising. With such a high failure rate among young companies, why would banks want to risk lending money to a firm not guaranteed to succeed?
Payments technology and processing servicer Vantiv has published a new white paper on where banks are failing their SMEs, and how they can regain market share from the cash flow financing newcomers – and do it profitably.
What SMEs Need – And Why
According to Vantiv, the majority of SMEs say they value access to credit, but just 15-20 percent of small businesses already have a bank loan. The figures suggest that banks are failing to meet the cash flow needs of small businesses: SMEs want financing to act as a reserve when times are tight, and banks can’t provide this security through traditional means.
Vantiv found that small businesses’ ideal financing option would be to access funds that equal between half a month’s revenues to one month’s revenues for unexpected cash flow problems, which can stem from anything from sudden equipment failures to hefty supplier invoice settlement.
Among SMEs that said they have had cash flow issues in the last year, nearly half (46 percent) cited large supplier invoices as the main cause. Bills piling up from vendors, unexpected repairs, tax returns and loan repayments were also popular responses.
These are common instances which squeeze an SME’s cash reserves and will likely always be a pain point for small business owners. But banks aren’t offering remedies to these situations even though, according to Vantiv, they should be considered “core” products.
High loss rates due to the high failure rate of small businesses is a major factor of why banks don’t meet all of the needs of small businesses. Banks also rarely implement risk-based pricing for SME customers, while banks also get stuck with high costs for some of the smallest loans they offer due to costs of reviewing applications, as underwriting is still done manually. “It is very hard to cover costs for loans less than a certain size,” Vantiv reports.
Where SMEs Turn
For banks, while the risks and costs associated with small business financing products can be high, they run the risk of letting a customer go. One-fifth of SMEs surveyed by Vantiv said that they would definitely switch banks to go to someone else who could provide the financial service they need.
Vantiv cites new market entrants like Kabbage and OnDeck Capital, which use Big Data to lessen the risk, underwriting and application assessment costs associated with SME borrowers. Analyzing a small businesses’ cash flow in real-time can provide crucial insight to lenders. Data, which can come from a merchant services or primary checking account, “helps reduce unit costs by increasing the automation of the underwriting process, and by improving risk discrimination (and pricing),” Vantiv concluded.
Other new market entrants like Square and PayPal, Vantiv highlighted, are now offering business lending products in their core payments processing services. “They already have the access to the transaction data through the acquiring relationship,” Vantiv said. “Why not leverage that to offer the lending product as well?”
How Banks Can Fight Back
While alternative lenders and payments processors are taking advantage of Big Data to gain stronger insight into small businesses’ cash flow and spending behavior, Vantiv argued that traditional banks similarly have this kind of data at their disposal – they just need to know how to access it.
Banks that offer SMEs access to its primary DDA (demand deposit account) can see, in real-time, how businesses are spending their money, and can use this information to more accurately and cheaply assess a borrowers’ creditworthiness. “Using DDA data allows the bank to underwrite all types of businesses and not just card-accepting merchants, which is a significant advantage over the receivables financing players,” Vantiv found. Plus, banks’ existing relationships with small businesses mean they can distribute financing products in more cost-effective ways.
While there are some capability gaps in banks – for example, not all banks are willing to front the costs and resources for launching a loan platform that automates underwriting – banks can form strategic partnerships to access these capabilities.
Taking action to offer more robust cash flow management products to small businesses, if done correctly, would add a new stream of profits for many banks. But according to Vantiv, the largest benefit from offering these services is the ability to create a competitive value proposition to “win over” key prospects, and the ability to maintain close ties with existing high-value customers, the report concluded.