We all know that businesses need cash to fund growth, but there are many ways to acquire such funding.
In this blog, we explore 5 sources of finance for a business to fund and grow your balance sheet, including overdraft, equipment finance, long term debt and surety in lieu of bank guarantees.
Overdraft/Working Capital Facilities
An overdraft is a working capital facility that allows businesses to continue to fund its accounts payable which is assisting in the timing of cashflows which needs to be balanced with the collections of accounts receivable.
The overdraft amount is a predetermined limit set by your financial institution and is available as both secured and unsecured lending.
Overdrafts are commonly used for:
- Paying bills and invoices
- Employee wages
- Purchasing stock
- Covering other costs, such as fixed/OH costs of the business
Pros of an overdraft facility
An overdraft can sit there and be available for a business only if they need it, which is a fall back strategy for the business to avoid missed payments.
Only pay fees when used
You will only pay fees and interest on the funds you withdraw
If your business has an overdraft in place it can be used at any time which falls back to it being a great safety net.
Cons of an overdraft facility
Overdrafts traditionally have a set facility fee and higher interest rate associated with the flexibility of the facility.
False sense of security
An overdraft can often mask the fact a business has cash flow and liquidity problems, which is why it’s important to continually monitor your business’ forecasting. Negative working capital may mean there is a systemic problem in the operating performance of the business.
Taking out an equipment finance loan is an effective way to finance business plant and equipment purchases whilst maintaining a strong cash flow. Most of the time businesses can secure an equipment loan for the full cost of the equipment with no additional security required (the equipment acts as the security).
Equipment finance solutions include:
- Finance lease
- Hire purchase
- Chattel mortgage
- Novated vehicle lease
- Import facilities
A traditional equipment loan is a great option if the business intends to own the equipment outright. Leasing options on the other hand are a great funding option for businesses that regularly update their fleet and other plant and equipment.
Pros of equipment finance
Businesses may be able to borrow the full amount it costs to purchase the equipment; hence they are not out of pocket to begin with.
Maintain cash within business
As the business isn’t having to find the extra cash to pay for equipment it can maintain its current financial position (of course factoring in the loan repayments).
Cons of equipment finance
Significant down payment
If a business is not able to borrow 100% of the equipment cost, there may be a deposit required upfront. The monthly repayments on equipment finance are fixed instalments for the term of the finance contract, if the business cashflows soften it can be problematic to suspend the monthly repayments with the financier.
Long Term Debt
Long term debt solutions are those with a maturity of 12 months or more and can include term loans, etc. Funding your business with long term debt rather than short term debt comes with many benefits including:
- Reduced monthly instalments which assists in preserving cash flow
- Extended pay back term of the loan normally is associated with the long term asset value that may have been acquired or used as security for the term loan
- Easier for cash flow management and saving liquidity in the short term
Long term debt solutions are a great solution to obtain immediate capital. Mature businesses utilise debt to fund regular capital expenditures as well as expansion capital projects.
Surety in lieu of Bank Guarantee
A surety bond is a bond/guarantee that can be provided in lieu of cash or bank guarantee as security that a business will meet its obligations under a contract.
So, rather than having cash or property tied up as supporting security for the traditional bank guarantee, surety bonds are unsecured.
Pros of surety bonds
Free up security
Because there is no cash or property tied up as security
Facility grows with the business
Providing the business with confidence when tendering for larger projects and increasing the pipeline of secured work.
Cons of surety bonds
Surety bonds may not be available to all businesses, especially those with limited assets or new companies without a solid financial record.
Equity Finance Complimenting Debt Finance
A final source for consideration is equity from investors when it comes to funding your business growth. Equity finance is funding from venture capitalists, private investors, crowdfunding, crowd-sourced, government funding/grants etc.
Pros of equity finance
Equity on face value does not need to be paid back like a loan facility
As it’s not a loan, the business does not have to pay back the funding
Level of understanding across all parties involved
Those who are investing in your company understand what the company’s capabilities are and not only can they add their level of expertise, but they also know it may take time to start seeing some great results
No monthly repayments
There are no monthly repayments that you need to factor into your cash flow
Potential cons of equity finance
Sell a portion of the business
If equity finance is from a venture capitalist, angel investors or any other individual or business who is buying a share of your business then you might have to “give up” some of your business, so as the business owner you are diluting your interest
Multiple stakeholder involvement and required approval
Or, depending on the level of authority your investors require, you may also need to consult them before making any major decisions
Use of Leverage when Taking on Debt
When businesses take on any kind of debt, it creates financial leverage, increasing the risk and expected return on the company’s equity. There are a number of widely used financial covenants used by business owners and banks, which can help to evaluate how much leverage a company has. Examples of these financial ratios include:
- Interest Cover Ratio (ICR) >1.5x
- Debt Service Cover Ratio (DSCR) ≥ 1.25x to ≥1.50x
- Gross Leverage Ratio ≤2.25x to ≤2.50x
- Capital Adequacy Ratio / Debt to Equity Ratio 1 to 1.5x
Read more on financial covenants here or download our eBook.
It’s important that no matter what finance option you choose to fund your business that you conduct adequate research before making your decision. This means talking to your broker in the first instance and explaining what you need funding for. A particular funding solution may suit one business but may not be the best option for another. This comes back to having a complete understanding of your business and how the processes work both internally and externally.
If you would like to know more about what finance options are available for your business, contact your Ledge Finance Executive directly, or contact our offices and we will be more than happy to assist with any questions you may have.
Please note the information provided here is general in nature and does not constitute financial, tax or other professional advice. You should consider whether the information is appropriate for your needs and seek professional advice prior to making any decisions.
For more regular updates:
You may also like: