How to tackle vast array of loan options

YOU have decided to expand your business and require a new factory and are concerned the growth will place pressure on your cash flow. 

You have discussed the option of injecting equity or seeking out venture capital but have decided to borrow money. You approach your bank and ask for a loan and an overdraft.   

In stunned amazement, you are then confronted with many products, pricing options, working capital alternatives and international trade facilities. Welcome to the smorgasbord that are ‘financial markets’.

Do you take the long-term option or the short-term option? Do you take bills or term funding? Can you factor your debtors or do you take an overdraft, or is a back-to-back letter of credit better for your business? If you are somewhat confused then you are not alone.

Given the level of diversity, some financiers can tend to offer the traditional mix of a variable rate loan, a fixed-rate loan and an overdraft.  But it is an injustice to you and your business not to take advantage of the exciting array of products available. 

There are four main types of funding:

• Long-term funding (loans taken over a period in excess of 12 months). 

• Short-term funding or working capital funding. (Facilities that cater for cash flow requirements repayable within 12 months). 

• Trade facilities that allow for the interaction between businesses, nationally and internationally. 

• Facilities that can be used for the purchase of equipment, on or off balance sheet. 

Products are offered by a diverse range of financiers, including, building societies, credit unions, banks, equipment finance professionals and factoring companies. 

The trick is to understand what product is required and the company that best provides that service or product. 

If you need capital to meet the running costs of your business pending collection of debtors, then you have a number of options. 

Overdrafts are a traditional form of funding and allow you to overdraw you cheque account to an agreed limit prior to the receipt of your debtors.  

A less-accepted facility, which has gained in popularity over the years, is factoring or invoice discounting. 

In the US it is the most common form of working capital finance and is more popular than the overdraft. 

Factoring allows for payments to be made by the financier up to 80 per cent of the invoice at the time of issue. 

The remaining 20 per cent less costs is advanced when the debtor pays the invoice.

Factoring matches cash flow needs with the trading patterns of the business and can be financed without ‘bricks and mortar’ security. 

Many people have a misconception that factoring is only used by business that is having difficulties but it is companies experiencing rapid growth that truly benefit from factoring. 

With longer-term funding there are a number of features that should be considered: 

• What are the set up costs and monthly management fees? 

• Is there the flexibility to make extra payments? 

• Are there early repayment penalties or deferred application fees? 

• What security does the bank require and how much control will the bank have over your business? 

You should also consider any tax implications of the funding chosen. 

When buying equipment it may be better to use a ‘chattels mortgage’, which usually allows for the GST on goods to be claimed back within the first quarter after the purchase. 

If a lease were chosen, the GST would be claimed back over the life of the loan. Many banks are offering hedging strategies based on floors, caps and collars. These are all terms to identify the method by which you are taking control of your interest rate risk. 

These can be effective interest rate management strategies but in other cases it can be a complicated and expensive exercise. 

If you don’t understand ask questions. If you still don’t understand seek independent advice but never assume what you are recommended is always in your best interest. 

Understand your appetite and capacity for risk. Understand the true cost of the strategy offered and the flexibility of the facility to meet unexpected events. 

To simplify this subject, remember that financiers are the providers of products and services. The products they offer are there to allow us to establish, grow and provide for the day-to-day management of our business. 

Paul Rowe is chief executive of business management group Razor. Contact Paul on 0406 800 928. prowe@razorbs.com.au