P2P Lending

P2P Financing Tips

Dear Readers

In my last write-up, P2P financing update, I brought all of you to date with my P2P financing investment through Funding Societies Malaysia. As highlighted previously, P2P financing yields much better returns than traditional investment bonds and fixed deposits. Consequently, it is an effective investment to combat inflation.

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Credit: letstalkpayments.com

Every investment has an inherent risk. P2P financing is no different. The major risk of P2P financing is the risk of a default by a borrowing SME. Fortunately, the default repayment percentage through the platform established by Funding Societies Malaysia is a negligible ~2%.

As for me, I have received 3 monthly repayments (July, August and September 2017) out of an agreed 6 monthly instalments. I am at the midpoint of the repayment schedule which has been a breeze thus far. I do not foresee any hiccups in receiving all of my remaining capital plus interest.

Business Term Financing Fact Sheet

Funding Societies Malaysia makes available, to all of its registered investors, a Business Term Financing Fact Sheet (“Fact Sheet“) for crowdfunding purposes. The Fact Sheet contains all of the necessary information regarding an SME including its financials over a certain period of time. This information is obtained by Funding Societies Malaysia through a due diligence process.

Unfortunately, Fact Sheets are confidential and only accessible to registered investors. Hence, I am unable to disclose the Fact Sheet of my investment. However, Funding Societies Malaysia was very accommodating when they provided a sample Fact Sheet which can be obtained by clicking the link HERE. As the format of the sample Fact Sheet is similar to that of the format of other Fact Sheets, is therefore ideal to be used for illustration purposes.

For convenience, I will refer to the SME in the sample Fact Sheet as Chocolate SME. As you click on the above link, you will notice that there are several headings in the sample Fact Sheet. The headings and their contents are listed in the table below:

HEADINGS

CONTENTS

Financing Details Contains all of the terms of the financing including financing tenure, simple interest rate, effective interest rate (compounded) and other conditions of finance.
Investors’ Repayment Schedule Contains an anticipated repayment sum which investors are to receive for each instalment until the end of the tenure.
Company’s Summary

Contains vital information on the SME including its incorporation date, the nature of the SME’s business, paid up capital, employees, existing litigation, any blacklist and financing records.

Financing records will summarise the SME’s other financial commitments with other lenders.

 

Director’s & PG’s Summary Contains vital information about all of the directors of the SME.
Financials Contains the past audited financials of the SME.
Financial Ratios Contains an evaluation of the financials of the SME.
Bank Statement Summary Contains a snapshot of the SME’s bank accounts.
Risk snapshot Contains an outline of the risks associated with the SME.
Comments Contains important highlights made by Funding Societies Malaysia.

The sample Fact Sheet contains information which you may analyse to make an inference as to the sustainability of the business and financial liquidity of Chocolate SME.

However, as a prudent investor, you should nonetheless read and understand all of the contents of a Fact Sheet. For the purpose of this write-up, allow me to list some of the major considerations which you should take into account prior to deciding whether to invest in Chocolate SME.

First consideration: Nature of business

Chocolate SME is a manufacturer of cocoa products in Malaysia, mainly chocolates. The chocolates are sold to chocolate retailers including the ones in Langkawi.

As excited as you are, at the thought of investing in a chocolate confectionery manufacturer,  you will need to satisfy yourself of the risks involved in Chocolate SME’s business.

But what makes a business risky? Well, any two persons looking at the same business may reach a different conclusion about the sustainability and risks associated with that business. Hence the answer to that question is better left to your knowledge, experience, power of observation and common sense.

For example, if an SME is in the business of selling typewriters, I would categorise it as a risky business. It is apparent, through my knowledge, experience, observation and common sense that not many people, if at all, are still using typewriters.

As chocolates is a popular confectionery and there is a strong demand for it in Malaysia – especially in a tax haven like Langkawi. Therefore, there is no reason for you to discount the sustainability of Chocolate SME’s business.

Second consideration: Debt repayment history

Ever heard of the saying, “History repeats itself”. The knowledge of the debt repayment history of an SME is crucial in gauging whether it has the means to make timely repayments.

In the case of Chocolate SME, the “Payment Behaviour and Financing Record” item of the Fact Sheet indicates that Chocolate SME has a good payment history across 2 existing accounts. That means that it is truly committed and financially capable of satisfying its debts.

Third consideration: Current ratio

The “Financials” part of the sample Fact Sheet consists of a summary of the income statement (the upper part of the Financials) and the balance sheet (the lower part of the Financials) of Chocolate SME. Some parts are blacken out as the information is not currently available.

With the available information, you should analyse whether Chocolate SME has too much debt for its own good in the short term. Why short term? It is because the financing tenure is only for 12 months (See: “Tenure” under the heading of “Financing Details”) . Therefore, it is only necessary to look at the ability of Chocolate SME to service its short term debt.

For the financial year-end (“FYE“) 2016, Chocolate SME had about RM2.7 million in current asset. Current asset is classified as an asset which is likely to be converted into cash within a year. For example, inventories are one of such types of assets because they can be easily sold in return for cash. Other types of current assets are cash (or its equivalent), equipment and receivables (money owing by debtors).

On the other hand, in the same year, Chocolate SME had about RM370k in current liabilities. Current liabilities are classified as moneys due to creditors within a year and are usually short term debts and account payable (to utility provider, suppliers and etc).

As a general rule of thumb, you want to invest in an SME which owns more current assets than current liabilities. This can be measured by using a current ratio.

Current ratio = (current assets ÷ current liabilities) x 100%

The current ratio of Chocolate SME for FYE 2016 was about 720%. This means, for FYE2016, Chocolate SME had roughly 7.2 times more current assets than current liabilities. Very impressive indeed.

Fourth consideration: Inventory turnover ratio

An inventory turnover ratio is simply a measurement of the effectiveness of an SME in dealing with the sales of inventories. In other words, how good is Chocolate SME in selling their inventories. Why is this relevant? This is because the more inventories are being sold – the more income that is generated by Chocolate SME. And by having more income, there will potentially be better cash flow to pay off outstanding financing liabilities.

An inventory turnover ratio is obtained by dividing the cost of goods sold with the average inventory. The higher the ratio, the better.

Inventory turnover ratio = cost of goods sold ÷ average inventory

For FYE2015, the inventory turnover ratio was at 6.70. This means the inventories were sold 6.7 times over during the course of FYE 2016. Even though it was lower than the than the 7.14 and 7.74 recorded for FYE 2013 and FYE 2014 respectively, that difference is not too far off.

Fifth consideration: Receivables Turnover

Receivables turnover ratio is a measure of how efficient Chocolate SME is able to collect receivables. Receivables means money/accounts to be received by Chocolate SME from its debtors. The more money Chocolate SME receives, the better it is for its cash flow. Consequently, a better cash flow translates to a better ability to pay monthly financing repayments.

A receivable turnover ratio is calculated by dividing net credit sales with the average account receivable. The higher the ratio, the better.

Receivable turnover ratio = net credit sales ÷ average receivable

For FYE 2015, the ratio was 7.40. This means that Chocolate SME was successful in collecting 7.4 times the average receivables during the course of FYE 2015. The ratio of 7.40 was slightly lower than the 8.75 and 8.37 recorded for FYE 2013 and FYE 2014 respectively but not by a huge margin.

Sixth consideration: Risk Snapshot and Comments

The Fact Sheet also contains Funding Societies Malaysia’s comments and observations of the financials and the risks associated with an investment in Chocolate SME.

I find that these observations are insightful as I was able to discern that:

  1. Chocolate SME’s products are sold on a healthy profit margin which has been improving other the years.
  2. The purpose of the financing is to expand its production capacity. I would be less inclined if the purpose of the financing is to pare down other outstanding debts.
  3. The directors of Chocolate SME are experienced business people.
Conclusion

Before I end, I just want to reiterate that the above considerations are not meant to be exhaustive in nature. There are many other considerations which you can take into account in determining whether a SME has a sustainable business model with the means of making financing repayments.

And more importantly, I hope that this write-up will arm you some guidance, courage and the confidence to nudge you into investing in P2P financing as a means to diversify your investment portfolio.

Your safeguard to the risks in every investment, including P2P financing, is knowledge.

Till then, happy investing!

Helpful links

Click the link if you would like to know more about P2P financing with Funding Societies Malaysia.

Click this LINK to register an account with Funding Societies Malaysia and earn RM50 when you deposit and invest RM1,000.00 through them. 

If you find this write-up helpful, please hit that like and share buttons on my Facebook for more updates and analysis.

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