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Debt finance
Short term sources
Long term sources
Short term sources
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Trade
creditors
When your supplier provides you with goods and allows you time
before you have to pay him, this is in effect an interest free
loan (although your supplier should have costed in the credit
they will allow you in pricing the job!). The more that you
are able to borrow from suppliers with their agreement in this
way, the less you have to borrow elsewhere.
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Overdraft
Much UK business funding has traditionally been by way of overdrafts
as they tend to be the most flexible banking facility offered.
An overdraft is a short term facility intended by banks as a
'revolving credit' to cover temporary timing differences between
payments you have to make to suppliers and receipts from customers.
Banks will therefore expect to see the account swing back into
credit on a regular basis and do not expect to see it used for
purchasing long term assets. As a short term facility, an overdraft
is usually repayable on demand.
The bank will also generally look to take some form of security
for an overdraft by way of charges over a parcel of assets.
Because of this approach to taking security over a range of
assets (some of which such as stock and debtors will vary in
value significantly from day to day), banks will take a relatively
cautious view in assessing the real value of their security
while specialist at lending against specific types of asset
may be able to lend more (as shown in how
much can you borrow?).
Overdrafts are also time consuming for banks to manage so expect
to see banks moving more and more customers across to factoring
facilities as an alternative to overdrafts.
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Factoring/invoice
discounting
These allow you to raise money against your outstanding debtors
by in effect selling the outstanding invoices to the lender
who will advance you say 80% of the approved invoices immediately.
As the lender takes over the debtors as security which are then
not available for a bank to secure its overdraft, completion
of a factoring deal usually involves paying off the overdraft
out of the proceeds of factoring the ledger being taken over
In factoring, the lender takes over management of your sales
ledger and actively chases in payment, which can in itself be
an advantage if your credit control has been poor.
Invoice discounting is usually only available to businesses
with turnovers of greater than £1,000,000 and differs
from factoring in that you continue to run your own sales ledger
and collect in your own debtors. As you are continuing to do
the work, it is therefore possible to have confidential invoice
discounting which means that your customers will not be aware
of the arrangement.
Some invoice discounters will take stock with confirmed orders
into account and are then able to offer higher levels of advance
against invoices (sometimes exceeding 100%).
The issues you need to consider are:
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With factoring you will
lose control of how your customers are chased for payment. |
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Your facility will be
based on a percentage advance against approved invoices.
The actual advance you receive as a percentage of your
total debtors can be significantly less than this 'headline'
percentage as the factor may disallow debts over 3 months
old, overseas debts, or may set 'concentration limits'
where individual customers' debts cannot be more than
a set percentage of your sales ledger. You need to look
at the nature of your debts and ensure that you will not
run into such problems with your factor. |
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Some debts are difficult
to factor. There are only a limited number of factors
who will deal with 'contractual' debt involving stage
payments (such as construction contracts). |
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As the advance is tied
directly to invoicing, factoring is well suited to fast
growing companies as the financing automatically expands
as the business grows. |
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However, as the facility
is tied to sales volume, if sales fall, so does the funding
available (which may be just the moment that you need
finance the most!). |
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Once you have this type
of facility in place, it can be extremely difficult to
get to a position where you can exit the arrangement. |
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There is still a stigma
attached to factoring in some circles as it has been seen
as financing of last resort, however as banks have moved
more customers to this form of financing, this stigma
is disappearing (and of course is avoided with confidential
invoice discounting). |
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Factoring and invoice
discounting are often perceived as expensive however when
comparing costs against bank facilities it is important
to compare against the total cost of equivalent bank facilities
including interest, management charges etc to get a fair
comparison.
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Bridging
loans
These are normally short term loans that typically allow you
to spend money that is anticipated (usually from the sale of
an asset such as a property), before the cash has been received.
There are some specialist funders who will offer 'bridging'
loans against property essentially as 'emergency' funding. However
while this can raise say 70% of the security value of a property
within 2 weeks, this type of funding is extremely expensive
and interest rates can often run at 2% a month.
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Long term sources
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Bank
loans ('term loans')
If you are looking to invest in long term assets such as plant
and machinery or property you should borrow over a period that
matches the expected useful life of the asset being bought so
that it repays the borrowing over its useful life.
It is usually better to seek a loan over a longer term than
you think you need (which will usually mean lower periodic payments
and allows you longer than you think you need in case of difficulties),
but aim to repay the loan in a shorter period. If you are seeking
to do this however, you need to check the terms of the loan
for repayment penalties which might make this uneconomic.
Fixed rate loans offer you certainty over the payments you will
make (but can therefore be inflexible and have repayment penalties
built in).
Variable rate loans tend to be more flexible but leave you exposed
to uncertainty as interest rates change over time. If you are
borrowing significant sums (say over £250,000) you may
be able to buy what is in effect an insurance policy against
interest rates going up in the form of a rate cap.
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Mortgages
A mortgage is essentially simply an example of a long term loan
secured against a property and all the points above apply.
Where a business has a property that is not fully lent against,
remortgaging this is usually the cheapest and easiest way to
obtain finance.
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HP
Hire purchase involves you in agreeing to purchase an asset
by making payments in instalments over a set period.
Hire Purchase agreements vary widely in their terms offering
fixed or variable interest rates and you need to check the rates
carefully (particularly where there is an interest free period
as rates for the balance of the term are likely to be high).
Some Hire Purchase agreements are structured with low ongoing
payments and a large ('balloon') final payment in settlement
at the end.
In general, while you will be responsible for maintaining and
insuring the asset from day 1, legal ownership will remain with
the finance company until the last instalment is paid.
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Leasing
With leases, the finance company always retains ownership of
the asset and there are two basic types of lease:
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Finance lease usually
used for major items of plant and equipment where the
finance company buys the asset and the business pays a
long term rental that covers the capital cost, interest
and charges and is responsible for insurance and maintenance.
Once the capital is repaid there may be an option to purchase
the equipment outright or to continue to rent it indefinitely
for a small fee ('peppercorn rent').
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Operating lease
typically used for smaller items such as photocopiers
where the equipment is rented for a specified period and
the finance company is responsible for servicing and maintaining
the equipment. Contract hire is a type of operating
lease where the renter is responsible for day to day maintenance
and servicing (eg often used for motor cars).
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You may need to pay an initial deposit
in setting up a lease and from a tax point of view, while the
rental can usually be treated as a cost, as you do not own the
asset you cannot usually claim capital allowances on it (nor
can you generally use the asset as security for other borrowings
as it does not belong to you).
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Sale and leaseback
As an alternative to borrowing against an asset, it is sometimes
possible to arrange to sell the asset (plant and machinery or
property) to a finance company to release cash and then to rent
it back. This is a specialist area (particularly in relation
to property where you need to be dealing with properties valued
at £1-2,000,000+) where you need good local
advisors.
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Directors
loans
There is nothing to stop you as a director lending money to
your business if you have funds available or can obtain cash
by selling or borrowing against personal assets such as your
house.
Obviously however you should think very carefully about whether
it is sensible to do so in respect of your business and should
seek professional advice from a local
advisor.
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