Irregular cashflow a common issue, adviser says
In a recovering economy, business owners want to invest in their business for future growth and many are turning to non-banks to do it, a financial adviser says.
According to Infometrics 2023 figures, self-employed workers represent 15.9% of the workforce, the highest percentage working in construction. While there is an opportunity to earn more, income can be irregular and more difficult to document.
Sandeep Khanna (pictured above left), financial adviser at Sandeep Khanna Mortgages, acknowledged that economic growth had been weak, and said many businesses had experienced increased costs and irregular cashflow.
Statistics New Zealand June quarter GDP figures (to be revised) showed 0.2% negative growth and a 2.6% fall in retail sales over the year to June.
With interest rates falling and expectations activity will lift, Khanna said business owners now saw an opportunity to invest in their business for better times ahead.
“Some of these business owners are heavily reinvesting in their business, so they need cashflow loans,” Khanna said.
While many business owners were able to show a consistent level of sales, Khanna said that operational costs often negatively impacted net profit.
Due to cost challenges, he said that some business owners had started working in their business. Taking on the role of an employee instead of replacing them and allocating that salary to themselves was often a stumbling block for getting finance approved.
“Most of the main banks want to look at the first three to six months of consistent income, so net profit has to be really strong,” Khanna said.
Campbell Smith (pictured above right), country head at Pepper Money NZ, said that the nature of being self-employed meant that income could be irregular and more difficult to document.
Traditional lenders typically require PAYE statements and tax returns, a level of verification which he said many self-employed people that Pepper Money worked with could not provide.
Irregular income a common hurdle
Khanna noted that the hospitality industry had continued to encounter challenges following COVID-19 and said that irregular cashflow was common. Businesses operating in construction and trades such as grouting and painting had also grappled with higher costs and a downturn in work, he said.
Many of those seeking loans were unable to provide the standard requirement of at least 6-to-12 months’ worth of income.
“For example, if I’m working as a chef and start a café business, we try to mitigate the situation by saying the applicant has earned $80,000-$90,000 as a chef, worst-case scenario he can always go back to being a chef,” Khanna said.
“Still there is push-back … the situation is similar for some franchisee businesses.”
Khanna acknowledged that the catch-22 was that business owners want finance to invest for future growth, which in turn would support higher income and net profit in years to come.
Differences between banks and non-banks
In response to differences in lending practices between banks and non-banks, Khanna said that a common example was where a business had a loan on an asset such as a truck, repaid through the business.
Some banks view the full loan repayment as an expense, whereas Khanna said that non-banks he had worked with took a broader approach.
For example, where a freight business has an $800,000 truck loan and a $600,000 home loan, total debt of $1.4m would often be assessed as an expense. The truck may be earning the business revenue of $40,000 to $50,000 per month; however, a monthly repayment of $6,000 to $7,000 would still be incorporated into lending calculations.
“A non-bank doesn’t tend to limit the lending based on the expense of the repayment of the asset,” Khanna said.
Flexible options available, non-bank says
Smith said that alternative documentation (‘alt doc’) loans had become a “necessary solution,” offering flexible income verification options tailored to individuals.
He said that it was common for a bank to ask for two years of income as part of its criteria for mortgage lending, taking the average when assessing a self-employed borrower’s ability to service a loan.
Non-bank lenders such as Pepper Money were often able to use accountant letters and bank statements as proof of income, up to specified loan limits, he said.
“Some of the flexible verification options for alt doc products from non-bank lenders like Pepper Money include accountant letters and business bank statements, with which Pepper Money will consider loans of up to $2.5 million,” Smith said.
Using what he refers to as a “cascading credit model,” Smith said that the non-bank lender was able to consider “a range of financial backgrounds,” including people with past credit issues.
“This flexibility enables self-employed individuals to present a more detailed picture of their financial health, increasing their chances of securing a loan,” he said.
Smith also said that non-banks were able to differentiate between self-employed business owners and contractors.
"When it comes to self-employed and contractor applicants, we recognise the unique nature of certain industries like real estate agents and builders,” he said.
These professionals pay withholding tax as part of their payment arrangements, much like PAYE employees, he said.
“As a result, they can at times be considered as a full doc customer under Pepper Money policy."
Weighing up cost versus potential gain
Khanna said that he would start with a main bank and if finance could not be offered, would consider a non-bank as an alternative.
“This can be a short-term solution and if the situation changes in the next financial year, we can change it,” he said.
Khanna said that interest rates applied by non-banks tended to be 2-3% higher and also charge a fee, which he said business owners needed to weigh up against the benefits of investing in the business now.
“If you’re looking at buying a property for $500,000 today, you’re paying $15,000 to $20,000 per year extra in interest compared to a main bank,” Khanna said.
Viewed through a business lens, based on a 5% long-run average growth rate, that property may be worth $25,000 more in a year’s time.
Khanna said that a non-bank could be used as a short-term solution. Providing repayments are made on time, the loan could be refinanced in six months to one year.
“It’s like investing in a business … you pay extra to secure that now, rather than waiting for six months to one year to pay more money for the same thing,” he said.
