UPPER LIMITS
Small- to medium-sized enterprises are getting smarter in their hunt for cash.
By Abe De Ramos

Yap Chee Keong's career looked gold-plated. A former group financial controller at Singapore Telecom and United Paper, Yap moved on to become head of finance in Asia for Burson-Marsteller, the multinational public relations group, and, most recently, CFO of Cap Gemini Ernst & Young in Asia. Then, just over a year ago, he jumped from the safety of the multinational world and went for the bright lights of the new economy.

Yap was lucky. He landed at Singapore-based System Access, a software provider that, along with other things, helps banks integrate head office systems with their acquisitions. Unlike hundreds of other e-businesses, System Access is still growing, with hopes of besting its record US$20 million sales last year. It has branch offices flung from Bratislava to Bangkok. And as the CFO of a small- to medium-sized enterprise (SME) with big company experience, Yap has the dream of a much bigger operation in his head. "It's a very exciting company," says Yap, justifying his move. "I'm not a techie, but to understand the applications of technology in day-to-day life is very intellectually stimulating. And certainly I think we have potential to grow to a size much bigger than what we are today," he says.

But first, the reality. Even with investment bank EM Warburg Pincus as a shareholder, the privately held firm is finding it difficult to raise the funds it badly needs. Last year Yap pushed marketing and product development at the expense of profits and this year he's paying the price. "It's a difficult period for any technology company wanting to raise money," he admits. His solution? Better management of working capital. "It's an underrated and often neglected source of funds," says Yap. "If we manage the working capital well, really, this should be sufficient for operating cashflow," he says.

The School of Hard Knocks

Say what? Those words seem surreal coming from a manager at an SME, where the head of finance is usually the cousin of the owner, or the managing director himself who took a few accounting classes in college. Fact is, a new consciousness in financial discipline is emerging not just among the largest conglomerates of Asia but in its small businesses as well.

It's about time, too. SMEs make up 95 percent of business enterprises in the region, employ 80 percent of its workforce, and contribute 60 percent of its economic output, according to statistics from Asia Pacific Economic Cooperation, the inter-governmental association that promotes trade in the region. The days when smaller companies could dodge and weave around the basic principles of sound financial management are over. "You must become an expert at (finance and) financing to achieve success," says Kenneth Jepson, executive vice-president at e-NetChina, an Internet service provider with offices in Beijing and the US.

Where did this enlightenment come from? The Asian crisis is a good start for the trace. Up until 1997, SMEs practically didn't have to worry about financial statements. The rah-rah years of the property market in every corner of Asia gave those with a building or a plot of land a ticket to funds. Now, banks are sitting on devalued property and SMEs are facing much tougher hurdles from their bankers: an up-to-date financial report with clear profit history, a detailed, well-argued business plan, and a credible management team. Increasingly, finance institutions are also relying on credit scoring mechanisms to replace human judgment on loan approvals.

Banks are beginning to notice the changes among SME finance managers, too. "It was not always that easy to understand the business of SMEs, because their financial transparency, historically, has not been as good as that of publicly listed companies or large multinationals," says Brian Robertson, head of corporate and institutional banking at HSBC in Hong Kong. "But it's improving," he says. To help this process, HSBC just completed a roll-out of 20 business centers within branches in Hong Kong, specifically aimed at generating more SME clients. Says Robertson: "SMEs are getting educated."

Not fast enough, however, to bring down the premium SMEs still pay for capital. In most of Asia, this premium still remains prohibitive even as interest rates have fallen. In Hong Kong, SMEs pay at least 400 basis points more than large corporations for comparable loans. The comparison to mortgages is almost the same - banks charge mortgages at prime rate minus 2.5 percent, while they charge SME loans at a minimum of prime plus one.

And of course, as long as these premiums persist, they make SMEs a juicy target for lenders. "Banks are looking for new opportunities, and the SME market is one of the few that large banks do not have a strong position in," says Terence Lo, analyst at Fox-Pitt Kelton, research arm of re-insurance giant Swiss Re in Hong Kong.

Cash is Power

No wonder, then, that SMEs still remain cautious about bank borrowing, and those who can still afford it are trying to make the best of what they have. Consider this from Isabelita Sy-Palanca, president of The Mother Company, which privately holds eleven SMEs in the Philippines: "Manage your cash well, because if you run out of it, then you have to borrow, and to borrow is no joke." Palanca and her six siblings inherited their business in smoked and dried fish retailing from their Chinese immigrant parents.

Over the years, their business grew from bakery franchises to an aerial photography and digital mapping company, with clients from Philippine Airlines to Itochu of Japan. Palanca's business philosophy: "Think big profits but small expense. Cash is power."

Size Does Matter

But taking size into the equation, it's easy to understand why power is such a hard thing for SMEs to grasp. SMEs are squeezed when large buyers wish to improve their costs. Just-in-time (JIT) inventory, while a boon for large companies, is a bane for their SME suppliers in difficult times. With JIT, front-end sellers take inventory of goods only when a purchase is certain. But for suppliers, this means they need to have the goods ready at clients' beck and call. "They're shifting the inventory risk to us," says Alfred Chow, CFO at Karrie International, a US$114 million-a-year company in Hong Kong that makes PC and server casings for IBM, Compaq and Canon.

The good news is that SMEs are finding ways to deal with these problems, and among them lies the basic principle of cash management: collect it. It may sound like a no-brainer for a large corporation, but for the powerless SME, this consciousness lacks practice.

Yap of System Access looks at his experience with SingTel to stress the importance of accountability in credit management. "If you are a big company and you have a monopolistic power, you can say, 'I'll just cut off your supply of our services,'" says Yap. "But if you're a smaller company, you need every customer to pay. You need to be more creative, innovative and cooperative in your approaches to the customer," he says.

As a vendor of software, Yap does it by being stern at the negotiating table. "You've got to get the payment mechanism right from the beginning, right from the contract negotiation," he says. "You negotiate the deal with the customer and clear these issues: how much they need to pay up front, when they need to [make the succeeding payments], and how much to pay." But Yap says finding the right payment structure is as much about educating the sales people as it is about negotiating skills. "I try to make sure that our sales people are focused on the right kinds of deals by helping them understand the business process of the customer - what issues they need to go through to be able to make a payment," he says.

Karrie's Chow agrees, saying: "The boss and marketing, they are all sales people, concerned about getting orders." Chow, as CFO, injects the importance of credit review. This goes beyond calling up Dun & Bradstreet or a local credit bureau to check on the financial strength of a potential client. "Ability to pay is different from willingness to pay," he says, and echoes Yap about a mutually agreeable payment structure. "Some guys may be happy to pay you, but they can delay and delay (the payments), and they will ask for discounts," says Chow.

Strength in Numbers

But beyond the principles of cash management, other bright ideas are also coming to light. Khuned Sachdev, who runs a small paper manufacturing joint venture in Indonesia, also heads iLaboratory, an incubator of Thai e-businesses. Undeterred by the collapse of the dot.com frenzy, he wants to bring the Silicon Valley concept of clusters to the island resort of Phuket. "You hear Phuket and you think tourists. But [some of] these tourists are staying there, and some of them are experts in Java and other programming languages," he says.

Under the clustering concept, a group of SMEs in similar ventures work together to combine their expertise and their bargaining power. A venture that designs golf clubs, for example, can work with one that makes them, and another that distributes them. The result is a more defined business prospect and strategy - an important confidence-building factor as far as banks are concerned. So far, Sachdev has gotten the support of entrepreneurs, and the curiosity of banks and investors, with his idea.

Clustering is not just for technology. Palanca, who heads various trade groups in the Philippines, says entrepreneurs in Negros, a flower growing region in the Philippines, is building a cluster along the lines of the Netherlands' tulip industry. "The idea is, we're not competing with each other even if we're into the same product; we're competing with somebody overseas," she says. "LetÕs group ourselves together, so instead of my buying, say, one yard of ribbon, we will buy five yards," adds Palanca. With the economies of scale, clusters should be able to get materials cheaper and borrow funds at lower cost. The idea is gaining support. The Philippine Chamber of Commerce and Industry, the largest trade group, has agreed to shortlist clusters and endorse them with banks - not a financial guarantee, but an assurance of quality.

Until the notion of clusters really takes off, other SMEs are seeking more traditional fixes - and this is where financial discipline and a good knowledge of alternative funding sources come in. When, in 1998, Karrie faced a crisis where all but one of its 18 bankers called in its loans, Chow turned to factoring, a process that uses receivables, not real estate, as collateral. When banks were chasing Chow for their loans, he noticed that a US$500,000 receivable from IBM was taking a while to process. So Chow gathered US$5 million worth of receivables, sold them at an 80 percent discount, and paid the banks. Then the factoring house collected the receivables and Chow got the balance of 20 percent, minus fees. In most cases, factoring fees are at least 0.1 percent of invoice value.

Having survived the crisis, Chow now says his former bankers are knocking on his doors again, but says he will stick to factoring for working capital needs. "In bad times, a factoring house is going to support you, and in good times, they are going to expand the facility tremendously to further support you," he says.

Despite its usefulness to Chow, Chong Mong Ting, managing director of East Asia Heller, a joint venture between Hong Kong's Bank of East Asia and Chicago-based Heller Financial, says factoring has yet to be accepted by most SMEs in Hong Kong. In the past, it was hampered by the Chinese issue of losing face, he says. "People think that when your customers find out that you're securing your receivables to borrow money, you must be very desperate," says Chong.

Dangerous Decisions

Elsewhere in Asia, finance companies themselves are skittish about factoring, mainly because they consider it a higher risk than real-estate-secured lending. "There is no hard collateral, it's just the receivables being held onto by the finance company, so obviously we charge higher effective rates," says Robert Lapid, head of marketing at PCI Leasing and Finance, the largest leasing and factoring company in the Philippines.

Singaporean bankers agree. As export trade leans towards open account (i.e., without the use of letters of credit), banks only offer factoring when the exporter has export credit insurance, according to the business development manager at a recently merged bank.

While SMEs across the region are getting savvier about setting up and using these kinds of techniques, there is still a way to go before they have the sophistication they need. Bankers complain, for example, that finance managers at SMEs will routinely fail to match credit facilities to the actual funding need. "You don't necessarily fund the purchase of equipment with an overdraft," says Palanca.

Likewise, some SMEs buy too much of one item on credit, and keep it unused in their warehouses for future use. Also, once the borrowing has taken place, SMEs need to improve their cash planning skills for repayment. Chong of East Asia Heller points out that some SMEs approach him with a proposal to fund an equipment purchase that would secure a new order for a year. "You finance equipment over four years, but you only have secure orders for one year? They ought to ask themselves if they really have to own the equipment," he says.

SH Teh, finance director at Adampak Graphics, a US$8 million-a-year Malaysian manufacturing and printing company, understands this well. He worked long and hard to negotiate with banks to get the best rate for a US$3 million upgrade in production plant and office area in August. But as interest rates have been falling, he is looking at pre-paying the loans. When markets improve, Teh says he looks forward to listing on the Kuala Lumpur Stock Exchange (KLSE). "We're working towards tapping funds from the KLSE, in order to swap bank borrowings, and for further capital investment requirement," he says.

In fact, leasing of equipment is available from suppliers themselves, if you know how to ask and you have a good credit standing. Henry Chow, chief executive of IBM Greater China explains that more than 25 percent of his group revenues are from SMEs. "We can't ignore them, so we provide leasing," says Chow. IBM relies on third-party credit information providers to check on a customer's credit track record.

Yap of System Access, meanwhile, says grants from governments are also a cheap, oft-neglected source of funds. For further funding, CFOs need not look farther than their income statements. "Tax is not a very glamorous area; it's below the line but it's a cash outflow, so we need to manage that," says Yap. "Once you start to export your product and services to other countries, there's always a danger that you may be exposed to double taxation," he says. Governments are aware of this, so much that a double taxation treaty is one of the first bilateral agreements when two heads of states meet. "You just have to be aware and take advantage of this," says Yap, who saves on taxes thanks to a double taxation treaty between Singapore and the Czech Republic, among other countries.

Equally important, clean and clear financial reports will get SMEs a long way. "When you look at financial reports you often see a mix between company and personal finances, a mix between company assets and personal assets," says Robertson of HSBC. "SMEs think it's not worth paying the money to have a reasonable firm of auditors do the accounts. Possibly, but unfortunately we'd like to see things audited by reputable firms in a timely manner," he says.

For those seeking venture capital or equity funding, Jepson of e-NetChina urges SMEs to go the distance. "You must use GAAP (Generally Accepted Accounting Principles) in addition to your region's preferred accounting methods," says Jepson. "It's impractical to expect investors to learn an unfamiliar accounting system," he says.

As the Chinese proverb goes, better to master a small skill than to accumulate a big fortune. Still, for SMEs, if the skill mastered is finance then good fortune might well be on the way. Asians have never lacked the entrepreneurial spirit, but old, bad habits kept them from growth. Now is their chance to actually have a shot at becoming Asia's future giants.

Abe De Ramos is a senior writer for CFO Asia based in Hong Kong.