Wendy Gibbs, Hertfordshire Growth Hub
Choosing the wrong type of finance for your business can prove costly not only in terms of fees and interest but also in your ability to raise further finance. You can however avoid some of the pitfalls by doing your homework first and being prepared. This article gives a brief overview of some of the different types of long and short term finance available including what lenders may look for, what they expect of you and what you should ask them. Please also refer to the article “Before you even think about raising finance” which provides a number of points you should also take into consideration.
The following is for guidance purposes only and when considering any form of finance it is recommended seeking support from a business bank manager or business adviser and your accountant who will be able to advise you of any benefits or implications regarding tax and depreciation, particularly in relation to financing an asset.
Short term finance
Overdraft facilities offer a short term borrowing solution which allows you with prior agreement to exceed the amount that you have in your Bank account.
Banks will charge for an overdraft facility this could include an arrangement fee, interest charges and fees to renew and/or increase the facility. So check with your Bank how much the fees are, how interest is calculated and when they are charged.
Before approaching your Bank you should prepare a cash flow forecast and whilst the Bank may not always request to see a copy of this it is necessary as it will identify how much finance is required, when and for how long, it will also:
The information you need to provide to your Bank will vary depending on the amount you are requesting and your existing relationship with them. You may also be required to offer security, therefore before applying ask your business bank manager what they need before you apply, that way you are prepared. Remember Banks have lending criteria if you can’t meet this criteria you are unlikely to be successful in your application.
If agreed the Bank will set an expiry date for the overdraft limit to be repaid, this could be for a few months to a year. At expiry they may also agree to renew the facility but don’t take this for granted if you still need to use an overdraft from time to time approach the Bank around one month before the expiry date to discuss renewal. Despite an expiry date you will probably find in the terms and conditions that the overdraft is repayable on demand meaning the Bank can withdraw the facility at any time, although they typically have a reason for doing so.
The Bank will also generally expect your account to return to credit for a period of time each month.
Business credit cards are another form of short term borrowing they offer a pre-set limit that will generally apply to your business, this limit can then be applied to one card holder or across several cards if you wish to authorise other directors or employees to also have a card for business expenses.
Applying for a business credit card is usually straight forward but ensure you ask for details of card fees, interest and repayment terms as these vary depending on the provider. There may also be additional fees for adding cards holders, cash withdrawals, overseas transactions etc. so it is best to check with the card issuer.
Generally you will have the option each month to either repay by minimum monthly repayments which are a percentage set by the card issuer or the full amount outstanding.
Factoring and Invoice Discounting
Factoring and Invoice discounting allows you to receive payment quickly for B2B invoices you have issued rather than waiting for your customers to make payment within their agreed terms, usually 30, 60 or 90 days. This can help with cash flow and some providers of these services will also allow you to decide which of your invoices you wish to use this service for.
There are some differences between factoring and invoice discounting that you need to consider:
Depending on which option you choose and the terms offered by the company providing the service you may initially receive a percentage of the invoice value then the remainder once your customer has paid. In both instances there will be fees for these services and you may also be expected to demonstrate that your business has a proven track record and financial controls in place.
Long term finance
Typically for the purchase of assets this is a long term finance option over 12 months or more with repayments made monthly for the agreed term. Some lenders may offer a repayment holiday which can be useful however keep in mind that the total amount repayable is likely to increase.
Interest rates will vary depending on the lender and the amount borrowed, plus you may also be charged an arrangement fee. If you think you may be able to repay the loan early check if there are any financial penalties for early repayment before you apply and agree to the loan. Also keep in mind that if you intend to use funds to repay the loan early whether the funds may be needed for other business expenditure, as once used to repay the loan they will not be returned and there is no guarantee that a new loan request would be agreed.
You may find that a lender will not provide a loan for the full amount of your intended purchase and that they expect you to fund a percentage. They may also request that you provide security such as a personal guarantee, a charge over an asset or both.
As the information you need to provide to the lender will vary depending on their requirements and criteria make enquiries in the first instance so that you are prepared. If you are unable to meet the criteria it can be worth mentioning this to the lender, your accountant or business adviser as they may be able suggest other options. For example where security is not available the Enterprise Finance Guarantee may be an option for viable businesses and lending applications.
This provides finance for an asset through either lease finance or hire purchase but there are some key differences.
Lease finance: the asset is owned by the finance company and leased by the business with fees, repayments and interest terms agreed by the leasing company. At the end of the lease term the leasing company may allow you to rent or in some instances purchase the asset.
Hire purchase: the finance company provides the asset and agrees repayment terms with you. At the end of the agreed period you own the asset.
Both options will incur interest and fees which should be checked with the finance company and you may be expected to have a proven track record which is evidenced by your accounts.
The asset belongs to the finance company so if you don’t make repayments the asset may be repossessed.
It is recommended seeking advice from a qualified professional such as your accountant when financing an asset to discuss any pros and cons relating to tax and depreciation.
The above covers just some of the types of finance available and it is possible that you may use a mix of these and others.