Finance
Many small and medium-sized businesses require finance. The need for finance and support from your bank or finance broker is particularly important when a business commences, experiences growth or experiences tougher operating conditions such as those we now face due to the global credit crisis. Grant Rheuben reports.
There are a range of finance options available depending on your current position, growth and goals; however there have also been some changes to business lending over the past 12 months that will need to be taken into consideration when planning your business finance requirements.
What has changed?
As is the case with residential lending, there has been a significant shift over the past 12 months in lending guidelines for business and commercial loans. This has created consolidation of available lenders and loan products. Some types of lending are becoming more difficult to secure and increasingly the lenders are asking for more evidence on the strength of a business, and in some cases are requesting additional security.
Unlike residential lending, there has been less reduction in interest rates charged to business customers. The Reserve Bank has reduced its cash rate; the majority of banks have passed these reductions to customers for residential lending. However, for commercial or business customers the rate reductions have not been as forthcoming. In some instances, existing customers have experienced increases to the margin paid on their loan during their annual review process with the bank.
Where can you secure finance?
Most business finance is currently available through major banks as they have the size and access to funds to support business lending, although there are still some non bank lenders in the market.
Borrowing through a major bank will have advantages, particularly in the area of additional services or total business finance packages. This can include internet banking, operating bank accounts, merchant facilities, business credit cards, leasing and the issuance of bank guarantees for lease of premises.
Making proper use of these additional services can help to streamline your cash flow management and maximise your profit margin. In fact, sourcing additional products from a bank in conjunction with your loan application can increase the likelihood of securing the loan funds you require because the Bank will also benefit from the supply of these services.
Business loan options
There are three main types of finance available for small to medium enterprises requiring a business loan of up to $10 million: debtor finance, cash flow lending, and property security. Often a combination of these will be used to provide the most suitable and flexible outcome.
Debtor Finance
There is often a long period of time between when stock is ordered and when you receive cash from a buyer. Debtor finance helps to cover this period, without relying on residential or commercial property to act as security.
Debtor finance is generally available to businesses with turnover of least $2 million per annum. Another major condition is that your business must not rely on a single customer for a large part of yearly turnover - in other words, you will need to have a good spread of customers.
It works by establishing a facility limit, which is determined by sales volume. Recognition of sales growth is included in the assessment of this limit. Once established, you can draw on the facility up to its limit as required. Interest is only charged on any cash drawn down and a fee is charged on the overall limit. As your business grows further, you will generally be able to increase the facility limit to provide the extra cash flow needed to keep expanding with demand.The lender will provide cash up to 80 per cent of the value of the sales invoice to help fund working capital, pay wages and purchase stock. For example, if you raise $200,000 of sales invoices for the month, the bank can deposit up to $160,000 (80 per cent) upfront in to your bank account, improving your cash flow. The advancement of funds by the Bank is secured by the respective sales invoices. The remaining 20 per cent of the invoice is received once the customer pays the invoice.
Cash flow lending
Cash flow lending is where funds are provided to a business against the goodwill and/or stock of that business. It is often used when acquiring another business. The lending criteria for cash flow lending are quite strict, making this type of finance more difficult to secure than debtor finance. You will need to provide evidence of steady, strong profits to secure a cash flow lending facility. The lender will create covenants to monitor business performance. These covenants will be monitored quarterly, half yearly or yearly depending on the strength of the transaction. An example of a covenant is the interest cover test, which takes the business profit before interest and tax and divides it by interest paid. The results of the interest cover test must be at least 1.5 times before a lender will consider you for cash flow lending. The bank will also impose reporting covenants to monitor their position, such as the provision of profit and loss and balance sheet statements every quarter, to ensure the financial position of a business does not deteriorate. Cash flow lending will cover approximately 50 per cent of the assessed goodwill value of the business. The remaining 50 per cent must be funded from other sources, and for this reason cash flow lending is often used in conjunction with debtor finance or by using property as security.
Property security
A finance facility secured by property is the cheapest and easiest type of business finance to secure. Generally speaking, lenders will prefer residential property as it is a less risky form of security than commercial property.
When using residential property, the bank will lend up to 80 per cent of the value of the property. Around 65-70 per cent of the value of a commercial property will be advanced, down from 75-80 per cent prior to the credit crisis. If insufficient cash contribution is available, a loan ratio of 75 per cent can be negotiated with an agreement to reduce the loan to 65 per cent of the property value in three years time.
The interest rate, fees and charges will generally be lower when residential property is used as security.
Documentation
As with any type of loan, a range of supporting documentation will be required. The amount of information that lenders require has increased over the past 12 months thanks to tougher credit conditions internationally. Documentation you may have to provide includes:
* Last two year's financial statements and tax returns
* Cash flow budget including an understanding of the assumptions made
* Business plan
* Tax portal or running statement showing all Australia Taxation Office (ATO) payments are up-to-date
* Bank statements of the operating account for the past 12 months.
A good commercial broker will be able to confirm the documents your lender will require for each type of finance facility application.
Business finance: a case study
An importer and wholesaler of clothing required a $3 million advance to purchase stock and finance working capital. The need for finance was in part a result of an acquisition.
The company directors did not have enough property to achieve funding via property security only. Therefore, funds were provided in two parts: $2 million as debtor finance and a further $1 million secured by residential property owned by the company directors.
The debtor finance facility was used to fund the cash flow cycle from when stock was purchased through to the sale of goods and collection of moneys from the end customer. The remaining $1 million was set up as a secured bank bill facility to provide additional cash flow if required. Because of the fluctuating nature of working capital requirements, the business only paid its interest if the bank bill or debtor finance facility was used.
The extensive experience of the company directors, strong business plan, strong historical financial results, good debtor listing, spread of customers and preparation of cash flow budget were determining factors in the final decision by the lender to approve finance.
Plastic Fantastic - the new finance stream
Cash flow difficulties are one of the leading causes of death for small to medium fashion businesses. Finance firm Octet capitalised on this sobering fact late last year by launching a business-to-business credit card, providing unsecured and accelerated working capital to businesses in their purchasing and sales cycle. The card is similar to that found in Average Joe and Jill's wallet - only with a higher facility limit and with an aim to plugging the gap between cash outflow from purchases and inflow from sales. The card was an extension of the company's business-to-business credit card facility for imports into Australia from China and Hong Kong, launched in February 2008.
Factoring – the classic finance stream
A "classic" cashflow alternative is factoring – also referred to as cash flow finance, debtor finance and invoice finance. Essentially, brands contract a factor to provide an immediate injection of cash against the value of their outstanding invoices. A factor pays a percentage – on average around 80 per cent – of the invoice value and manages outstanding receivables by collecting payments from retail customers. Fees for factoring services often vary depending on a brands' annual sales volume, the credit worthiness of their customers, average invoice size, payment terms and future business plans. Brands are charged for the money they use and a service fee.
Bibby Asia Pacific, cashflow finance solutions provider, says demand for its factoring service has grown over the last 6 months in response to the current environment. Chief executive Greg Charlwood says the company can typically release up to 90 per cent of the cash in unpaid invoices for completed sales within 24 hours.
"Businesses in the fashion industry, particularly those importing stock from overseas to wholesale, face inherent cash flow challenges due to the long cash cycles and seasonal nature of the business.
"Additionally, in a tight credit environment, these facilities are easier to access as they don’t require real estate security or add to long term debt levels, allowing the business owner to minimize personal risk. "