Beyond cost, the financing decisions of a business will be driven by the specific needs of the business or purpose of finance. Below we look in more details at the factors which influence short-term and medium/long-term finance.
The easiest form of short-term finance is trade credit, which can be relatively quick to arrange. The typical amount involved here will depend entirely on your trading activity. The terms agreed again will depend upon your industry and business. The reverse is also common, where a business will be requested by its customers/clients to agree trade credit terms.
For the management of short-term cashflow bank overdrafts will normally provide sufficient flexibility to deal with fluctuating finance requirements. A business may operate within an agreed facility without drawing the full amount available or may make full use of it or even exceed the agreed amount.
Cashflow finance/invoice factoring is often used to manage short-term cashflows and to bridge the funding gap created during the period from when an invoice is issued to a buyer to when the buyer pays for the goods/services.
Cashflow finance is available only to those businesses which sell goods and services on a business-to-business basis, with no staged payments, and is particularly suited to those that have high levels of working capital tied up within debtors; examples could be manufacturers, wholesalers, engineers, transport companies and labour hire/recruitment service providers.
Business credit cards may also be useful in bridging cashflow gaps, especially for managing employee travel and entertainment expenses and low-value procurement transactions. Corporate credit cards allow for simple payment processing, helping companies monitor and manage employee expenses, and can help manage the company’s liquidity and enhance the ability to manage suppliers by providing supplier spend analysis.
A purchase/procurement card for low-value procurement is a payment solution that can deliver significant process efficiencies together with visibility of spend over high volumes of payments and suppliers; it may also help driving savings compared to traditional purchase order and paper-based processes, as well as reducing the need to keep petty cash.
Options are more complex instruments that can be used to manage short-term variable cashflows. Such contracts are derivative financial instruments in which two parties agree to transact an asset at a specified price and before or at a future date. Option contracts can be used by businesses to manage the risk of adverse changes in financial markets conditions, such as interest rates or exchange rates, or in the market price of specific assets, like commodities.
Currency options are those added to FX forward contracts. At expiry of the option, users have the choice of exchanging or not exchanging currencies at the pre-determined forward rate. Options are normally used by large businesses with significant financial exposure to fluctuations in financial and commodity markets. The option premium is the price of an option sold on an exchange market or charged by the writer.
Loans are a common form of finance for medium and long-term funding. Loans are generally a quick and straightforward way to secure the funding needed, and are usually provided over a fixed period of time. Loans can be used for a variety of purposes such as to finance start-up capital or to finance the expansion of a business or to fund the acquisition of equipment or premises.
Hire purchase (HP)/leasing is an alternative to business loans when items of equipment need to be financed. HP is suitable for businesses wishing to have the option to purchase assets without paying the full value immediately.
HP/leasing is particularly common in industries where expensive machinery is required, such as construction, manufacturing, plant hire, printing, road freight, transport, engineering and professional services. It is also used to finance smaller items like cars and photocopiers. Although HP and leasing contracts tend to be more expensive than loans, they offer more flexibility in the financing of assets as they do not require actual acquisition and therefore shelter a business from the risk of an asset’s value depreciating quickly; additionally a business may choose to enter into a new contract at the end of the original lease’s fixed term.
Friends and family are a popular option for businesses seeking medium to long-term funding, to support their start-up or expansion phase. A share of equity is usually the route if your business requires a longer term investment. You must manage expectations of your friends or family and explain that there is a risk that they may not get all their money back.
Business angels are common sources of medium-term to long-term finance for start-ups and established small and medium-sized enterprises (SMEs). They typically provide early investment capital and often provide ‘intellectual capital’ (for example contacts or experience to enter a new market).
Business angels require a higher annual return from a business than other forms of finance and require an exit plan to be put in place to allow the angel to leave the business. Exit costs will increase in line with the size of the equity stake taken.
Stock market listing raises long-term equity finance for a company by offering shares to potential investors via a regulated market. Listing on a stock market is unlikely to be suitable for smaller businesses as the process involved can be time-consuming and costly and investors will be looking for a company that has secure earnings streams and strong growth prospects.
Stock market listings raise capital for a business’s consolidation and growth objectives, attract private investors into a business and facilitate an owner-manager to cash in on their investment.
A barter transaction is simply the exchange of goods or services, in exchange for other goods or services. Bartering benefits companies and countries that see a mutual benefit in exchanging goods and services rather than cash, and it also enables those who are lacking hard currency to obtain goods and services.
Barter has developed into a sophisticated tool that can sometimes help businesses increase their efficiencies by monetising their unused capacities and excess inventories. Modern barter and trade has evolved considerably to become an effective method of increasing sales, conserving cash, moving inventory, and making use of excess production capacity for businesses.
The advent of online bartering sites has made multilateral bartering more common. A trade or barter exchange is a commercial organisation that provides a trading platform and bookkeeping system for its members or clients. The member companies buy and sell products and services to each other using an internal currency.
It is typical to obtain grants when you are looking between 15% and 60% of the cost of a project. Grants are usually available for specific projects - for example a new product or process, job creation or training programmes. The normal growth of a business would therefore not normally qualify for a grant, though an established business looking at creating more jobs could qualify.
Trade loans are an important and well-established trade finance technique. Particularly suited to wholesalers and manufacturers, they can be used for regular or one-off purchases of goods and raw materials. Trade loans are a flexible, short-term borrowing facility, linked to specific import or export transactions. They are available to firms regardless of the method they use to trade, whether it’s on an open account, collections or documentary credit basis. Trade loans help fund trade transactions throughout a firm’s trading cycle, improving their cashflow.