‍Determining the Financing amount needed for the business is a great challenge for the SME owners because getting a Financing lower than the required will not fulfill the business’s capital needs and getting a Financing higher than required will increase the cost of the business unnecessarily. For this, the SMEs should follow a proper guideline to calculate the Financing amount needed.

Determine the financing gap:

To find out how much financing is needed for the business, the SMEs should create a budget plan of the business expenses and prepare financial projections of the business including its estimations on revenue and profits. If the earnings of the business are lower than its budget projections, the business can decide on taking a Financing to fill up the financing gap.

Determine the purpose of the Financing:

The owner of the SME should determine on what purpose, the Financing amount will be used such as purchasing new equipment, developing and launching a new product, increasing business production level, and expanding marketing activities etc. In this way, the business will determine the amount needed. For example, if the business plans to launch a new product it may require a larger amount of Financing, but if it needs to buy a new machine, the Financing amount can be lower.

Determine how much Financing the business can afford:

Based on the estimated financing gap and purpose of the Financing, the business needs to determine how much Financing the business can afford. In this case, the business owner should assess the debt service coverage ratio(DSCR) and debt-to-income (DTI) ratio to determine whether the cash flow of the business will cover the payment amount of the Financing. A higher ratio will indicate that the business can repay the Financing amount.

Determine the length of the Financing period:

The SME owner needs to determine whether the Financing will be short-term, medium, or long-term and assess how long it will take the business to repay the Financing amount from positive cash flows over that period. Based on the business profit projection and Financing period, the SME can estimate its required Financing amount. For example, if the SME requires a5-year Financing and it has a profit and cash flow projection for 5 years, it can take a Financing to an amount lower than its projected cash flow, so that Financing can be repaid within 5 years.

Determine the cost of the Financing:

Based on the Financing period, the business owner needs to calculate the total cost of the Financing including the Financing principal and interest payments. Comparing the Financing cost with business profits and cashflows, the business owner can decide how much Financing would be appropriate for the business. For example, if the business takes a SR5000 Financing for 5 years at a 10% interest rate, the total cost of the Financing would beSR8052 (SR5000 and SR3053 profit). Thus, if the business can earn higher thanSR8052 during this Financing period, it can take a Financing of SR5000.

Determine future financing needs:

The business owner needs to assess future financing needs based on the growth plans of the business. If there is a need for near future financing, the business can take short-term Financings, otherwise, the business can long-term Financings. In this case, if long-term Financings are taken, it might be difficult for SMEs to get new Financings before existing Financings are repaid due to a fall in credit scores. Thus, the SMEs can look for low-cost short-term financing for the business such as invoice financing.

For example, if the SME requires to buy a piece of new equipment for SR300000 and has capital only in the form of an outstanding invoice of SR400000, the business can use invoice financing to buy the new equipment needed for the business. In this case, the SME can have an invoice finance deal with a financial institution to give80% upfront with a charge of 3%. Thus,

·       The total invoice value= SR400000,

·       The invoice advanced amount=(SR400000x 80%) =SR320000

·       Reserve amount = (SR400000-SR320000)=SR80000

·       Invoice fees and charge= (SR400000x3%) = SR12000.

This way, the SMEs can collect an invoice advance ofSR320000 and use it to buy the new equipment. After the customer pays the outstanding invoice, the payment will go to the financial institute. In this case, from the reserved amount, the SME will get (SR80000-SR12000) = SR78000.Thus, based on the service fees rate and reserve rate, the SMEs can calculate the Financing amount in invoice financing.

A peer-to-peer (P2P) invoice financing platform in Saudi Arabia is firstly introduced by Lendo which provides low-cost invoice financing services to small and medium-sized enterprises (SMEs). Lendo helps its clients to get urgent business finances through invoice financing and has a lower rate of charges. For detailed information about Lendo and its services click here.

‍

‍