Functional Credit: The Wants, the Needs, the WTF's?!?
Sven von Sperl
May 4, 2022
First, let’s define what we mean by functional credit. The short version is the old phrase ‘Cash is King’. It’s a phrase we’ve all heard and sometimes used to refer to the importance of cash flow in the overall fiscal health of a business, so functional credit is the ability to source that cash as and when needed from an appropriate facility (corporate card, overdraft, loan, etc). The importance of sufficient cash as an asset in a business for short term operations, purchases and acquisitions can be under-appreciated by businesses of any size. It certainly happens more often in the early stages of a business as I’m sure most, if not all, of the readers of this blog would have at some point heard the stats from the old 2005 UTS study.
“One in three new small businesses in Australia fail in their first year of operation, two out of four by the end of the second year, and three out of four by the fifth year.”
But a business of any size can lose sight of its cash flow, Virgin Australia is a fairly prominent example. You’d be forgiven if you thought it was purely the COVID-19 pandemic’s impact on the travel sector that was to blame, but the truth is it was probably just the final push before the company had to take some fairly dramatic steps. Virgin Australia had posted losses for 7 consecutive years prior to the travel restrictions and had nearly twice the amount in current liabilities as it had cash at the end of the 2019 financial year. That’s why when they couldn’t secure a loan (the functional credit) during the pandemic they were left with no other option than to go into administration.
So having access to cash and functional credit is vital for any business, even more so for young and small to medium businesses. I mean, we can just quickly list the top 3 benefits we see and assess if they’re worth having access to:
Increased cash flow flexibility
Additional capital to invest in income generating activities, reducing opportunity cost or increasing revenue/profitability
Cleaner recording keeping (Not having staff reimbursements or mixing personal and business spending from directors.)
If you’re a small or medium sized business, all of those benefits can make the difference in enabling better decision making and your business thriving into the future. Stuart Brandman of 542 Partners explains further, “It's really the impacts on cash flow that are most relevant. Typically, a business may need to incur costs, to derive revenue. Take a salesperson for example, they might need to fly to a location to meet a customer, take a rental car or Uber, stay in a hotel, to then generate a sale. That sale might occur on 30 day terms, and the business is paid some 45 days after the whole process begins and costs incurred. Credit cards are usually on a 55 day term (up to). This fits extremely well with the revenue cycles of many businesses and can seriously help to align cashflow more attractively. This is especially the case with start up businesses, or businesses with longer lead times to revenue.”
So this all begs the question, why is it so hard for businesses to access functional credit and have sufficient cash on hand?
Assessing the Barriers
Let’s have a look at the application process for something like a Westpac Business Credit Card or really any of the standard card providers. In order to successfully apply you’ll generally need to:
Earn a minimum $30,000 per annum
Provide personal tax assessments for last 2 years
Business financial statements (latest available profit and loss statements, balance sheets and tax returns); or Business plan for new start-up business.
As a director, provide personal indemnity or guarantee the debt for the business impacting your own individual credit score/history
And this is before addressing any additional requirements they may request based on the size of the credit limit being applied for or looking at the fees for the facility.
And there are more questions to consider, let’s take the final point about director liability for example. In Stuart’s experience, or at least historically, the only way to obtain a “credit card” for a small business (new or established) is to get a “personal liability” business credit card. That's a fancy way of saying “we’ll put your business name on the card so it looks cool” but essentially, it's a way of separating your business spending from your personal, but it remains your personal liability.
This can be ok in some situations, but in others it can be quite difficult:
What if the business owner already has personal credit cards (which most likely they do). Their limit for credit and window of available credit will be shrunk. This might mean a very small business card limit, which might not be practical.
What if there are multiple business owners/directors? Who should bear the personal liability? Who should have a reduction to their borrowing capacities? Whose credit rating is affected by the business default?
Foreign companies coming into the Australian market often find this difficult. Quite often a foreign company may only have a nominee director in Australia. This can make obtaining credit difficult, and to fund employees on the ground operations in Australia.
In summary, it’s incredibly difficult for businesses to access even small amounts of credit. With limited access to that functional credit, a business that may have otherwise grown into a juggernaut could become one of the UTS statistics and fail before it’s ever taken off. So, what needs to change?
Change the Rules, Change the Game
First things first, let’s just appreciate that banks aren’t likely to change their risk appetite, which is why the rules are the way they are. Fundamentally, I believe business founders and bankers are different people due to the seemingly substantial divide between their risk tolerance levels. But, if they could change just these few details, we’d likely see more businesses survive and thrive under the right guidance of an advisor.
Underwrite the business directly, it’s a business loan so put it in the name of the business. With advances in Open Banking and interconnected data sources, it’s much easier to track and manage the risk of the facility not being paid back.
Enhanced controls, it’s not enough anymore to simply give the card over and say ‘best of luck with your venture’. Business owners need visibility and control over their spend, especially if there are multiple staff members who are going to have access to it. Smart controls and visibility via a software portal/platform would not only improve the business owner's life, it also decreases the risk that money will be wasted and the facility is unable to be repaid in the terms set.
Ditch the inflated points program, as humans we have a subconscious habit to compare everything, but there is a bug in the way we do that when things aren’t the same. We’re great if it’s two apples and one looks a bit off, but if it’s the value of a points program vs the dollars paid in fees, we’re not so good. Now I’m not so delusional to think that banks are going to give up revenue or think that business owners don’t enjoy being spoiled a little, that’s not what I’m saying. I’m saying, bring it back to a cash back program so that one card benefits program can be assessed fairly to another or if you want to stick with points let’s come up with a universal scale so that the value of those points is more transparent and easier to assess side by side.
These are some really simple fixes and they would go a long way to making access to functional credit easier for business owners and avoiding the sometimes costly work-arounds (staff reimbursements via payroll) we have become so conditioned to thinking is normal.
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