As management accountants, we are frequently asked questions from our customers about borrowing money and raising finance. Below we share some of our experiences from over the years that we have been helping small businesses.
An overdraft is a very flexible way to raise money. The bank will agree an overdraft limit with you, and then your business can borrow up to this limit without further conversations with the bank. You can dip in and out of overdraft and only pay interest for the period when you are borrowing.
The downside to an overdraft is that the bank will frequently charge an arrangement fee to set it up, and then an annual fee each year to renew. So, although the interest paid might be low, as you only pay when you need the funds, this can be offset by annual fees. The other downside is that banks are becoming less willing to offer new overdrafts.
Borrowing money using a loan requires more planning and forecasting. Before you apply for a loan, you will need to work out how much your business needs to borrow in total and how long it will take to pay it back in full. Your bank will most likely ask to see this cashflow forecast before agreeing to lend, we would recommend asking your management accountant to help you prepare the cashflow forecast.
The most frequently used banks loans are term loans that run for a period of 2-5 years. The business would borrow the full value of the loan at the beginning and make a fixed value loan repayment every month plus interest until it is repaid.
With short-term bridging loans, the business would borrow the full amount, and then make a single repayment and pay all the interest in one go at the end of the loan period. With term loans and bridging loans, there is normally an arrangement fee to be paid, as well as interest on the funds borrowed. Bank loans provide certainty but not flexibility. The amount being borrowed and the length of time it is being borrowed for are normally fixed at the start and the expectation is that they should not change. This makes it important to have an accurate cashflow forecast, and to monitor business against the forecast.
Another borrowing option available to you if you are buying a specific item of capital equipment is a form of asset finance. In this case, your lender will be lending the business money specifically to purchase the asset, and they will take security over the asset. The business might be offered finance to cover 100% of the purchase price, or more commonly, the business will pay a deposit of between 10% and 20%, and the finance company will then lend the remaining balance.
By taking security over the asset, the finance company reduces its risk, as they will own the asset if you fail to make your repayments, and by reducing their risk, they can provide lending at a lower interest rate. However, as the lender has reduced their risk, the borrower has increased their risk, as they risk losing their asset if they do not keep up repayments.
Invoice discounting is a useful method of borrowing for a business that does not have many physical assets. If your business does not own its own premises and it does not have any vehicles or plant and equipment, you might consider borrowing in the form of invoice discounting. The lender will buy your outstanding trade debtors from you, giving you an injection of cash, but as your customer pay their invoices, they pay that money to the lender, not to you. Then each time new invoices are raised, more funds become available to you, so it can feel a lot like getting paid as soon as you raise an invoice to your customers.
The downside to invoice discounting is that it comes with an administrative burden, as you will need to upload documents to the lender’s portal regularly, and it can have quite high fees associated with it. There will be an interest charge for the amount you are borrowing, but normally also monthly administrative charges.
We strongly encourage you to prepare a good cashflow forecast that you believe is achievable before you apply for any form of borrowing. Whatever amount you borrow, it will need to be repaid, plus interest and fees, and it is important that you are confident that your business will generate enough cash to make all the repayments on time.
Cashflow forecasting can be a bit tricky, and if there is no-one in your business that has prepared one before, it is worth asking an experienced accountant or bookkeeper to help you. Not only will this document usually be requested by the lender before they agree to advance funds, but also it is a great tool to use within your business to control the finances.
For more tips on how to prepare a cashflow forecast, read our blog here, or contact us for more information.
