Going international: How can SMEs finance foreign trade?

How can SMEs finance foreign tradeThe UK export market has grown significantly year on year, with the Government pledging to double the country’s export value to £1Tn by 2020.  And while UK SMEs make up 99% of all businesses, fewer than 20% of SMEs export to international markets, compared with over 40% of large companies.  So with the global spotlight firmly on our Government and its plans to help UK businesses succeed in a post-Brexit world, it is vital to ensure that SMEs can fulfil their export potential.

A report commissioned by World First, an international money transfer and FX expert, found that only five per cent of UK SMEs have plans to start exporting in the next five years.  However, by trading their goods and services internationally the typical exporting SME added more than £287,000 in revenue over the last 12 months with one in 10 of SME exporters also saying that exports had boosted their profits by more than 20 per cent.  But many are fearful that Brexit will hinder their ability to export, so it’s clear that inspiration and support are needed to seize the growth opportunities that exist in global markets.

Foreign trade comes with many challenges such as regulatory and commercial but SMEs report that the main barriers affecting them focus around finance – access to finance, fluctuating exchange rates and payment risk. Each issue has its own specific requirements and solutions.

Lack of financing is a major constraint to SMEs wanting to export as they are in large part reliant on a few banks; and bank lending, which has been declining since 2008, is not meeting their needs. Trade finance facilities from banks have also generally been more difficult to negotiate recently as SMEs often don’t fulfil certain bank lending criteria. At the same time, traditional capital markets are not open to SMEs in the way that they are to larger companies.

That being the case, evidence suggests that SME exporters tap only a small number of the available financing sources with nearly three-quarters relying just on their balance sheet, and have no external financing.  Lack of information is a major constraint. SMEs typically possess incomplete knowledge of alternative sources of finance.  On the supply side, the limited track record of SMEs makes lenders hesitant to lend. So, the development of alternative funding sources as complements to traditional bank financing has become increasingly important. Not only can they help to overcome the aggregate finance constraint, they also provide more flexible solutions tailored to each SME’s differing financial needs. New developments include: innovative ways to access capital markets; new financing platforms (e.g. peer-to-peer lending and crowd-funding); and new forms of asset-and sales-backed finance and supply-chain finance.

Another stream of financial support is available from the UK Government’s export credit agency, UK Export Finance (UKEF), which seeks to ensure lack of finance or insurance from the private sector is not a stumbling block for any viable UK export.  The support on offer helps exporters with their cash flow and protects them against not being paid, or helps with their finance needs in the case of the Export Working Capital and contract Bond Support schemes.

As with financing, lack of expertise in managing foreign currency volatility is a major concern for UK SMEs trading abroad. Many do not have the dedicated skills to deal with foreign exchange risk on export that can potentially lead to a contract becoming loss making and ultimately threatening the viability of the export initiative.

In an ITM survey, a quarterly economic confidence survey of more than 1,000 UK SMEs, 56 per cent said that currency volatility was a concern for their business.   Only 35 per cent admitted to using products to mitigate their currency risk, while the rest relied instead on more volatile spot markets.

Banks tend to offer products that allow companies to fix and hedge their exchange rate exposure only to larger companies with foreign currency needs of several million pounds. Smaller companies have generally been underserved when it comes to foreign currency issues, but an increasing number of specialist currency brokers can offer such products to companies with smaller FX requirements.   One of EFM’s international clients trades extensively in € and US$ and is constantly exposed to currency risks which could be highly damaging to its margins. Our part-time FD has supported the client with an effective hedging strategy to protect profits against any downsides caused by currency fluctuations. And we are now working with an expert broker to limit foreign exchange-related costs and de-risk the development of new markets and suppliers.

85% of international trade is conducted on open credit terms so it’s important that businesses protect themselves against the risk of non-payment and other loss. The cost to a business of non-payment can be considerable and devastating.  Many SMEs, when asked about credit risks for a report by URICA, said they relied only on credit checks and took the risks themselves whereas the more experienced exporter sought out other solutions. Cash up front was seen as a major way of managing risk and finance but this can put them at a considerable disadvantage compared with local suppliers.

Surprisingly, despite the fact that SMEs exporting products or services are often faced with the risk of non-paying customers, only a small number use export credit insurance.   Anticipating the risks and adopting measures to avoid them can help SMEs reduce the uncertainty of doing business internationally.

What can you do?

Finance your exports:

  • Research which type of finance best suits your requirements – traditional banks or alternative lenders.
  • Investigate Government-backed funding.

Manage your currency risk:

  • Avoid speculation and secure your margins through a fixed rate or forward exchange contract, protecting you from any unexpected currency fluctuations.
  • Shop around: Compare quoted exchange rates from your bank or a specialist transfer provider against the current market rate to see how much of a margin you’re being charged.

Mitigate your risk of non-payment:

  • If you are concerned about whether your customers’ ability to pay, try and negotiate payment up-front or setup payment in stages.
  • Protect your business from late (or no) payment; insure against non-payment of export invoices.