Need for external finance remains high amongst UK SMEs

The latest SME Finance Monitor from the UK’s largest business market research firm, BDRC, highlights a number of intriguing trends that emerged in 2014. One particular trend indicates that small to medium sized firms are refraining from formal ‘core’ borrowing, such as bank-arranged loans, business overdrafts and credit cards in significantly greater numbers than over the past few years.  

By drilling down deeper into the report, the findings contain some less comforting data. For one thing, it may be wise to be cautious, as the report itself suggests, about the use of apparently straightforward terminology like “SMEs”. Not all SMEs are the same, and that is not simply a function of size. Yes, some SMEs employ up to 249 people, while others, like sole traders, employ no one. There are other considerations too, like the owner’s age, what stage of development they are reaching, what their owners have come to feel about the processes and even the possibility of core borrowing. That is where the figures start to get interesting.

The headline figures suggest that the use of external finance has been steadily falling. In 2011, 46 per cent of the SMEs polled, of all sizes, used external finance. By 2014, this had fallen to 37 per cent. However, at this point, something interesting emerges. Borrowing from traditional sources of finance has declined, but a substantial 29 per cent of SMEs reported that they had injected personal funds into their businesses; roughly half of them said they had chosen to do so while the other half felt they had no choice. The need for external financing still exists; it is just being sourced less frequently from the banks. Clearly there is simply not enough 'personal funds' compared to the funds that used to be accessible from the banks.

The increasing presence of the PNBs helps to mask other changes amongst SMEs. For example, once the PNBs are excluded, 70% of remaining SMEs use external finance and this has increased steadily during 2014 (it was 63% in Q1 2014) back to levels previously seen in 2013.

Now, increasing forms of alternative finance is filling the whole in the supply. There are now other ways that SMEs are managing growth and cash flow issues. Of the respondents, 31 per cent said they had negotiated ‘buy now, pay later’ trade credit agreements with their suppliers. By using a broader definition of “business funding”, which includes trade credit and injections of personal funds as well as formal external finance from banks, the apparent growth in “Permanent Non-Borrowers” (PNBs) – those who have not borrowed from banks and do not intend to - is not quite as robust as it appears. In a nutshell, 37 per cent of SMEs used external finance in the form of bank loans, overdrafts, invoice finance and so on in 2014, and 15 per cent used none of these but received trade credit while 12 per cent were injecting personal funds. The widened definition of external funding raises the percentage of borrowers from 37% to 64%. 

Of those businesses least likely to be planning to grow and not considering external finance, most had no employees or an owner over 65 who had chosen personal funds rather than core borrowing. Younger businesses on the cusp of new growth were more likely to seek external finance, but many were put off by the ordeal of applying or previous negative experiences, which had led them to believe they would be declined.

If you want to grow your business faster, maybe it is time to look away from the banks and toward alternative finance sources instead.

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