By Diego Caicedo, Co-Founder & CEO of Portal Finance
The 2007 - 2008 financial crisis changed the financing landscape for small- and medium-sized businesses across the world. When Basel III was implemented, stricter regulations and risk averseness on behalf of banks damaged formal bank lending for businesses.
Ever since the financial crisis, there have been few alternative lending opportunities to fill the void. Reasons for this vary; however, banks stopped lending because of a lack of information and techniques to assess businesses coupled with businesses’ lack of assets to serve as collateral for financing.
Blockchain, the underlying technology of cryptocurrencies, is still in its early stages. However, we are starting to see how its applications may help organizations around the world operate more efficiently, reduce costs, and even discover new revenue opportunities.
With blockchain technology, information is stored in a way that it can be validated by all previous and preceding blocks in the chain. Blockchain offers a shared ledger that is updated and validated in real-time with each network participant.
In the world of financing, blockchain technology can enable distributed ledgers, with each block detailing the latest set of transactions and the chain containing all transactions that have occurred on the ledger to date. This validation and increased visibility of the ledger is also decentralized, preventing losses or duplications of information by any one network participant and providing more protection against security threats.
How blockchain can help alleviate cash flow pain points for SMEs
Many SMEs are dealing with cash flow issues because the traditional financing industry is not meeting their needs. Businesses that need cash flow to pay for materials, start the production process, pay employees, or cover any other business expenses, often turn to alternative forms of financing to obtain funds and ease their cash flow issues.
Invoice financing, or factoring, is one way. This form of financing involves factoring companies, or lenders, purchasing a company’s owed accounts receivable and collecting payments on those invoices. After payments are received in full, the factoring company takes a cut for their services and sends the differences back to the business.
This method of financing can be a practical option for businesses that have outstanding accounts receivable within the 60 to the 90-day range and need to release capital to operate their businesses. Blockchain has the potential to alleviate cash flow pain points in a number of ways using invoices, which are one of the most valuable assets an SME possesses. Invoices can serve as collateral to unlock cash flow and support business growth. This type of financial transaction represents an acknowledged, legally enforceable obligation between two legal entities and behaves in the same manner as a legally binding contract.
Manually assessing the risk of an invoice may involved a number of intermediaries. Factoring stands to be much more favorable for the factoring companies as well as their clients if the verification and payment functions can be decentralized using blockchain technology.
On a decentralized platform, both suppliers and buyers have access to necessary transactional information in real-time. From the initial order to final payment, every transaction takes place on a shared network. This transparency enables suppliers and buyers to reduce the need for human validation and approval of transactions, resulting in faster transaction processing improved cash flows for suppliers, and potentially better rates from invoice finance providers. Every step of the supply chain process is time-stamped and verified by all parties, meaning that information is accurate and immutable. This added level of visibility may also mean that businesses will have more invoice financing solutions available, too.
Blockchain and the principles of smart contracts can enable the transformation of invoices into smart transactions, allowing third-parties to participate in the purchase of these contracts and anticipate cash flow. Furthermore, smart contracts can represent an invoice, or any similar financial document, and be used as collateral to support a loan.
Adopting blockchain-based invoice financing
The adoption of blockchain technology in the world of electronic invoicing and invoice-backed financing will not happen overnight. As more and more innovative platforms emerge that combine traditional invoicing with blockchain solutions, forward-thinking SMEs that integrate this technology stand to benefit.
In the 2017 PwC Global FinTech Report, 20% of survey respondents reported they plan to invest in distributed ledger technology, or blockchain, within the next 12 months. Additionally, 77% of survey respondents stated they expect to adopt blockchain as part of a production system or process by 2020.
There is tremendous potential for blockchain technology to help SMEs not only unlock cash that is tied up in accounts receivable but also revolutionize their invoicing processes, providing a more secure, transparent, and irrefutable record of their transactions.
Diego Caicedo is the CEO of Portal Finance, a platform that evaluates electronic invoices from companies and leverages e-invoicing and open data in custom solutions for financial partners to fund SMEs.