A business’ capital is the money it has to sustain its daily operations and fund its future growth. Small and medium enterprises (SMEs) raise capital at various stages to ensure they continually have the ability to generate value. Financial capital is one of the two categories of capital in business and economics. It is typically cash or liquid assets held or obtained to cover expenses. Broadly speaking, the term can encompass all of a company’s assets which have monetary value like their equipment, real estate, and inventory. When it comes to budget, capital refers to an SME’s cash flow.
There are four types of financial capital: debt capital, equity capital, working capital, and trading capital. Businesses often attempt to distinguish the first three, though they often overlap.
Working capital refers to the funds an SME needs for its daily operations and to meet its obligations in a timely manner. On the spreadsheet, it is the difference between an SME’s liquid assets and its short-term liabilities. Potential creditors and business partners take into account an SME’s working capital when assessing their stability and creditworthiness.
Working capital can further be divided into four components: cash and cash equivalents, accounts receivable (AR), inventory, and accounts payable (AP). Cash, AR, and inventory fall within an SME’s asset column while the AP is regarded as a liability.
Equity capital refers to the capital raised from the issuing of the company’s shares. Equity here refers to shareholders’ equity or owner’s equity. It represents how much money would be returned to the shareholders when all the assets are liquidated and all of its debts were paid in full in the case of liquidation. Equity capital is often earmarked for business expansion. However, there are instances where it is used to cover daily operating expenses. SMEs moving towards listing may find their shares being traded on the stock exchange after their initial public offering (IPO).
Debt capital refers to the money an SME borrows. On the balance sheet, the amount borrowed is listed as a capital asset while the amount owed is recognised as a liability. Unlike equity capital, debt capital subscribers are not part owners of the company. Instead, they are creditors who would receive a contractually fixed percentage return on their loan.
Financing facilities offered by Funding Societies are a classic example of a platform that falls under the category of debt capital. Besides that, banks and other financial institutions may provide debt capital financing to SMEs as these institutions are authorized by the Financial Services Act 2013 and the Islamic Financial Services Act 2013 to provide loans to SMEs.
After having a clearer idea of capital, SMEs would be able to better identify the right capital raising strategy that meets their current and future business needs.
Capital Raising Technique 1: Shortening Operating Cycles
When an SME increases their cash flow, it contributes to its working capital. With that principle in mind, SMEs can raise capital by shortening their operating cycle. This means that SMEs are able to convert their money tied up in production and sales into cash. The odds of non-payment increase when that process takes a longer time.
Some strategies taken by SMEs include:
- Requiring a deposit or upfront payment before the commencement of work;
- Reducing credit terms to a shorter or palatable period;
- Expediting billing as soon as the sale is made.
Capital Raising Technique 2: Refrain from using Working Capital to Finance Fixed Assets
An SME’s fixed assets include their buildings, equipment, vehicles or land. Over time, SMEs may need to acquire these assets to better serve their customers. Naturally, these acquisitions are often expensive. Using working capital – which is meant to support daily operations – is advised against by many financial professionals as it depletes the funds and impacts the SME’s risk profile. In turn, the SME’s creditworthiness would be impacted.
As an alternative, some SMEs have taken these other approaches:
- Enter into a lease agreement to finance the fixed asset;
- Seek long-term loans to finance the acquisition of that asset.
Capital Raising Technique 3: Screen New Customers through Credit Checks
Though not normally associated with capital raising, running credit checks on new customers is essential before SMEs take them on or extend credit. Performing this due diligence, especially where the credit facilities could impact the SME’s cash flow, would save the business from cash flow hiccups in the future. A customer’s inability to honour the credit terms leaves bad debt sitting in the SME’s books.
Capital Raising Technique 4: Relying on ‘Other People’s Money
In finance, other people’s money, or OPM, is a colloquial term that refers to financial leverage. Some investors and institutions in the market have accumulated funds they are willing to lend to or invest in a credit-worthy SME. For an SME to deploy this mixed capital structure approach, they must ensure that their current and projected revenues would support the facility.
Some strategies SMEs may consider are:
- SMEs may raise capital through a registered equity crowdfunding (ECF) platform;
- An SME may obtain financing through SME digital financing platforms like Funding Societies to finance their capital growth or to liquidate their accounts receivable (AR) and accounts payable (AP);
- Micro financing schemes with participating banks and financial institutions which provide SMEs with business financing up to RM50,000;
- Participating in the various programmes provided by SME Corporation (SME Corp) which include an SME Revitalisation Financing (SMERF), Soft Financing Scheme for Small & Medium Enterprises (SFSME).
Raising capital for SMEs can often become a chicken-and-egg question: without capital, the SME cannot grow its capabilities; without added capabilities, the SME may not be able to raise enough capital. As discussed in this article, capital can be raised by leveraging financing facilities offered by third-party providers. It could also be raised through optimisation of internal processes to reduce risk and credit-to-cash conversion. Ultimately, the decision needs to take into account the business’s ability to fulfil its obligations while maintaining a responsible optimism toward the future.