Banks and non-banks provide a range of credit financing options for business. The type of credit that a business needs depends on a number of factors including its stage of development, trading history, financial status and how the business will use the funds.
New businesses should consider the full range of credit options and, where possible, consult with a professional financial adviser to decide which solution best meet its needs.
There are three broad types of credit available, depending on the length of the credit term.
Many businesses obtain finance to cover short-term or day-to-day needs, such as ensuring that the business has sufficient cashflow or cash at hand to pay expenses, suppliers or wages. This form of financing is especially important in minimising the impact of seasonal fluctuations in cashflow.
This is the main form of financing for day-to-day expenditure or working capital requirements and is linked to the business current account. An overdraft allows you to spend more money than is actually in your account. The amount by which your account can be overdrawn is agreed in advance and interest will be charged on the overdrawn amount.
Business Credit Cards
These enable businesses to conveniently pay for and track expenditure. The outstanding balance on the account is usually cleared each month. If the account is not cleared, interest on the remaining balance may be charged
Businesses often have significant sums tied up in debtors – money due from customers for goods or services provided and for which the business has issued an invoice for payment. Invoice discounting allows a business to get cash from its sales invoices earlier than it would otherwise be able to. It works by giving you access to a pre-determined percentage of invoiced debt. A bank may agree to immediately advance up to 80% of the value of approved outstanding invoices.
Enterprises with unsatisfactory or inadequate internal credit management and administration systems may choose to sell off a portion of their debtors, at a discount, to a financial institution or company in return for a one-off payment. The factoring company plays a more direct role in collecting outstanding debts than with invoice discounting.
Medium-term finance, covering periods up to seven years, is usually used to pay for purchases of or access to plant and machinery or motor vehicles, research and development, or expansion into new markets, but it may also be used as working capital.
A term loan is usually associated with the purchase of a major asset such as a motor vehicle or plant and machinery or with a major business expansion, although businesses can also use term loans for a range of other purposes.
Leasing – Finance Lease
For businesses that cannot afford to buy a business asset, such as a motor vehicle or machinery, leasing may be an attractive option. This enables the business (the lessee) to lease or rent the asset from a financial institution (the lessor) in return for regular payments over a fixed period of time. The lessor retains ownership of the leased asset.
Leasing – Contract Hire/Operating Lease
This is similar to a finance lease agreement, except that the lessor is usually responsible for maintenance and servicing of the leased asset.
The business makes regular payments to a lender in return for use of the asset, as with leasing. When all repayments have been made, the lessee then becomes the owner of the asset. Ownership of the asset only transfers to you when the last payment has been made, but you will have full use of the asset from the beginning of the agreement
Long-term finance is normally associated with investments in major fixed assets such as property, manufacturing plant and equipment or mergers and acquisitions.
Fixed Asset Loan
A Fixed Asset Loan enables a business to purchase plant or machinery and pay for them over the period of their useful life. Repayments can be made over ten years.
This provides long-term finance to assist in the purchase of new premises, the refinancing of an existing property or the purchase of an investment property.
Sale and Leaseback Agreement
The business may reach an agreement with a financial institution under which the firm sells property, plant or machinery to the institution, and takes out a long-term lease on the asset sold by the institution. This gives the business access to more cash but reduces the security in the business.