By Erez Saf – Pymes Capital and CRiskCo CEO, at Mexico Business News
Dear Small and Medium Business Owners,
Securing financing is critical for growth, yet many business owners and CFOs miss out on these opportunities due to low credit scores or unclear financial records. As the CEO of Pymes Capital, I see the potential in many of these businesses every day. But potential alone isn’t enough; lenders need clear financial metrics that demonstrate creditworthiness.
This letter is a call to action for us all to prioritize financial literacy and practical steps for strengthening your business’s credit profile. Here, I’ll provide specific numbers, tools, and targets to improve your business credit score and increase your chances of obtaining financing.
What Numbers to Aim For
Here’s a breakdown of specific financial targets and metrics that will increase your eligibility for financing, along with examples to illustrate each concept:
1. Days Sales Outstanding (DSO)
Target: 30-45 days or lower
DSO measures how quickly you collect payments from customers. A DSO of 30 days means it takes an average of one month to collect payments, which is indicative of good cash flow. If your DSO is above 45 days, consider strategies to shorten it, such as offering discounts for early payments or setting stricter terms.
Example: If you own a small manufacturing company and invoice a client for MX$100,000 (US$4,800) on Oct. 1, but they pay on Nov. 30, your DSO is 60 days. By negotiating payment terms to 30 days or offering a 2% discount for payments within 10 days, you could reduce your DSO to 30 days. This improves cash flow and shows lenders that receivables are efficiently managed.
2. Credit Utilization Ratio
Target: Below 30%
Credit utilization refers to the percentage of your credit limit that you’re using. Keeping this below 30% demonstrates financial discipline and shows that your business isn’t overly reliant on debt. For example, if you have a credit limit of MX$100,000, aim to use no more than MX$30,000 at any time.
Example: Imagine a small retail shop with a business credit card limit of MX$50,000. If monthly expenses on the card total MX$40,000, the utilization ratio is 80%, which could hurt the credit score. By keeping monthly charges under MX$15,000 (30% of the limit), you show lenders you can manage debt responsibly, boosting your credit score.
3. Customer Concentration
Target: No more than 20% of total revenue from one client
High reliance on a single customer can increase risk; if that client leaves, your revenue could take a significant hit. Aim for a diversified customer base, so no single client contributes more than 20% of your total revenue.
Example: A landscaping business relying on a single corporate client for 50% of its revenue faces instability if that client reduces its contract. Expanding services to residential clients or other small businesses reduces this risk and creates a more stable revenue stream, making the business a safer profile for potential lenders.
4. Revenue Trends
Target: Annual revenue growth of 5% or more
Positive revenue trends signal business health, so if your revenue has been declining, consider new revenue streams or seasonal promotions to even out slower periods.
Example: For a seasonal tourism company, revenue dips in the off-season can be a challenge. By introducing special packages or discounts during slow months or exploring new revenue streams like event planning, the company can boost off-season growth. Even a 5% revenue increase in the off-season contributes to long-term growth, making the business more attractive to lenders.
5. Debt-to-Equity Ratio (Financial Leverage)
Target: 2:1 or lower
This ratio shows how much debt your business carries relative to equity. A ratio of 2:1 means you have 2 pesos in debt for every peso in equity, which is a manageable level for lenders. If your ratio is higher, focus on paying down high-interest debt and avoiding additional loans.
Understanding Equity: What It Means for Your Business?
Equity represents the value the owners truly own in the business. If you’ve invested your own money in assets or accumulated profits over time, this contributes to your equity. A high equity level compared to debt signals to lenders that you’re less reliant on borrowed funds, which boosts financial stability.
How to Calculate Your Equity
Equity represents the value the owners truly own in the business. If you’ve invested your own money in assets or accumulated profits over time, this contributes to your equity. A high equity level compared to debt signals to lenders that you’re less reliant on borrowed funds, which boosts financial stability.
How to Calculate Equity:
Formula: Equity = Total Assets – Total Liabilities
Total Assets: Everything your business owns, like cash, inventory, property, and equipment.
Total Liabilities: Everything your business owes, including loans, credit card balances, and outstanding debt.
Example:
Total Assets: MX$270,000 (cash, equipment, inventory)
Total Liabilities: MX$120,000 (business loan, credit card debt)
Equity: MX$150,000 (270,000 – 120,000)
Debt-to-Equity Ratio: 0.8:1, indicating a balanced financial structure where the business relies more on its own funds (equity) than on borrowed funds (debt). For lenders, a ratio below 2:1 is generally considered manageable, as it suggests the business is not overly dependent on debt.
Practical Steps and Checkpoints
Improving your credit score can feel overwhelming, but you can achieve it with consistent actions. These steps can help you turn your current numbers into the lender-friendly metrics that make financing accessible:
Evaluate Your Financials Monthly: Review your DSO, credit utilization, revenue trends, and debt ratios monthly. Tracking these metrics allows you to make real-time adjustments.
Diversify Your Customer Base: Set a goal to add new clients or increase sales to smaller clients monthly. If one client generates a large revenue portion, work to ensure no single client exceeds 20% of income.
Automate Payments and Reminders: Automated invoicing can help reduce your DSO by ensuring prompt invoicing and scheduled reminders, encouraging timely customer payments and improving cash flow.
Monitor Credit Card Expenses Weekly: Regularly reviewing credit card usage helps keep the utilization ratio low. Set a spending limit well below the credit limit to prevent high utilization risk.
Prioritize High-Interest Debt Repayment: Focus on paying down high-interest loans if your debt-to-equity ratio is high. Even small, regular payments reduce debt over time, improving your financial profile.
The Bigger Picture: Financial Literacy for Sustainable Growth
Achieving these targets isn’t just about securing financing; it’s about building a stable and resilient business. By understanding and actively managing these financial metrics, you can not only improve your credit score but also gain insights that support sustainable growth. Educated, empowered SMBs are better equipped to thrive, create jobs, and drive economic growth in Mexico.
Let’s work together to make financial literacy and responsible credit management a priority. At Pymes Capital, we’re committed to supporting SMBs not only by offering financing but also by helping to build a financially informed business community. I encourage all SMBs to take action on these metrics today and leverage the tools available to gain control over their financial future.
Thank you for your dedication to building a stronger, more resilient Mexico.