It is essential to choose the right tools when you want to finance your business, The objective is to create mutual understanding among financiers and entrepreneurs when utilizing specific financial structures, be it for funding or credit enhancement. there are also guidelines that need to be followed when you want to source funds.
- Use any available cash you have, to cover working capital expenses.
- A business loan should match the useful life of the asset being purchased, so use a short-term loan for an immediate need, such as purchasing inventory; a medium-term loan for buying vehicles, equipment, and so on; and a long-term loan for purchasing equipment or a building.
Different financing options are best suited for funding working capital.
Working capital finance is used to cover day-to-day operating expenses such as paying supplies. The following financing is considered when looking to fund working capital needs:
1. Trade credit: This is when your suppliers fund you by providing goods and services for which you pay later. You can do this by requesting payment terms, in which you only have to pay for your received stock a few days, weeks, or months later.
Advantages and Disadvantages of Trade Credit
- For buyers, the benefits of trade credit include simple and easy access to financing. It is also a cost-effective form of financing, with no additional fees when compared to other forms of financing, such as a bank loan.
- Trade credits improve businesses’ cash flow because payment is not due until later; they can sell the goods they acquired without having to pay for those goods until a later date. Trade credits also help your company’s profile and relationships with vendors.
- The disadvantages of trade credit include high costs for late payments. Costs are typically incurred in the form of late-payment penalties or interest charges on outstanding debt. If payments are not made, this can have a negative impact on your company’s credit profile as well as your relationship with your supplier.
2. Overdraft: An overdraft is a type of financing available from your bank that is linked to your business account.
It is the amount of money available to you once your bank balance has reached zero. Overdrafts are simple to set up, and interest is only charged on the amount borrowed.
It is also known as a rolling credit facility because you do not have to apply for it every time you need to use it; you can use it whenever you need to.
Types of overdraft
- Authorized overdrafts are pre-arranged. You and your bank agree on a borrowing limit, and you can spend money up to that limit using any of the standard payment methods.
- Unauthorised overdrafts, also known as unplanned overdrafts, occur when you spend more than you have in your bank account without prior agreement, or when your bank has agreed to an overdraft for you but you exceed the limit they’ve set. You will be charged additional fees, which can quickly add up.
3. Factoring or Invoice discounting: Invoice discounting is a type of financing that allows you to manage your company’s cash flow by selling your customer invoices (accounts receivable) to a financial institution in exchange for immediate payment.
This option reduces profit margins and should not be pursued without careful pricing and margin analysis. When considering this option, seek professional advice.
Centre Both invoice factoring and invoice discounting assist ambitious businesses in expanding and growing.
They both refer to the same critical process: an assetbased working capital solution that allows businesses to receive advances on cash owed to customers rather than waiting for those customers to pay. Waiting for payment can cause real problems for many businesses, preventing them from investing in growth.
The various types of invoice financing enable businesses to free up capital that has been locked up in invoices with long remittance terms.
Since the credit crunch restricted bank financing, factoring and invoice discounting have become a major source of working capital finance. Invoice financing is more appealing to banks because it is based on the collateral of the debtor’s invoice. Following the credit crunch, new bank capital regulations have resulted in banks shifting businesses away from unsecured loans and overdrafts and toward this mode of lending.
How it works
1. You provide the goods/services to your customer and invoice them
2. You send the invoice details to the invoice finance provider
3. Funds are made available of a certain percentage of the face value of the invoice. Usually within 48 hours (see different factoring companies for invoice advance % details)
4. Either your own credit controller or the invoice finance provider’s sales ledger service carries out the invoice collection procedure
5. When your debtor pays, the balance of the invoice is made available to you – less a service fee
4. Short-term loans: These are loans that are payable in one year or less. Most businesses use short-term loans to even out cash flow. Short-term loans are ideal for:
a. Seasonal businesses may have to build up stock upfront (for example in retail)
b. Businesses with credit customers
c. Cyclical businesses e.g. construction businesses
5. Long term loans
Capital Expenditure: The money spent on purchasing assets such as ovens, refrigerators, and so on. Long-term loans are those that last more than a year and can last up to 20 or even 30 years. They are appropriate for when a company needs to make large purchases, such as equipment.
Most small businesses do not have enough money set aside to purchase large equipment, and even if they did, it makes more sense to keep the money to manage cash flow and get a debt loan to manage the equipment purchase.
The benefits of a long-term loan include lower interest rates and smaller repayments because you repay the loan over a longer period of time.
The negative aspect is that you end up paying back significantly more than the initial amount borrowed due to interest.