Every business, no matter the size, needs cash to succeed and grow. Often getting a small business loan is the priority, whether you are limited liability corporation (LLC) a sole proprietorship or a start-up enterprise.
Nevertheless, lenders will always put you and your business under a financial microscope to check the project viability before passing over a penny. They will look at your balance sheet and projected cash flow, your credit rating, and your company history. Once you pass a credit check, the lender will investigate your asset portfolio; assets are lenders’ insurance to guarantee payment.
What are assets?
1. Owner-occupied home
2. Cash savings or deposits
3. Business inventory including machinery and equipment
Maintain detailed records of all assets
Banks and lenders, notoriously undervalue assets, because if the borrower defaults, the lender will have to find a buyer and sell the items. Find an independent appraiser to value your assets.
Know what forms Asset Collateral
There are two types of assets – a) those you own and b), those which you still owe money. Banks will often consider a house mortgage as an asset. However, the most viable assets are those with full title ownership. For example boats, cars and planes!
Vacant land is not viable, even if you have full title. A working farm, on the other hand, will be given a more pleasing look.
Accounts Receivable and Business Inventory
For example, if you have a proforma invoice for goods with an inventory of sellable items and buyers, a lender will often lend against it. It is more tricky to negotiate a loan and never a done deal.
Cash is King! Savings and Deposits
Asset-based loans are low risk, and banks will hold CDs (Certificates of Deposit) and other financial investments as collateral. Your money is safe as long as you continue to service the loan.
Pros
Usually a less expensive loan to take
Tends to feature fewer covenants than other types of financing and those it does include tend to be more flexible
Repay the money as they need to without being constrained by set time frames that are commonly found in term debt or other debt instruments
Cons
Asset-based lending tends to be more expensive than other financing, often three to five percentage points more expensive than a typical commercial lending relationship, however, it is less expensive than cash flow or stretched-term debt in the marketplace
It is considered relatively dangerous to rely on short term assets for long-term debt.
LEASING / HIRE PURCHASE
An alternative to funding asset purchases by way of a bank loan. Leasing is a good choice if the item has high maintenance costs or quickly becomes outdated.
How leasing works
Direct Leasing – The leasing company buys the asset and rents it out to you over an agreed term at an agreed monthly rental
Purchase Leaseback – You sell to the leasing company an asset that you already own and it then leases it back to you
In both cases the asset is paid for over a fixed period (typically 1-5 years) by regular instalments. The asset is either returned to the leasing company at the end of the lease period or ownership can be arranged for a nominal amount
Lease finance is favoured by small business enterprises (SME), and individuals, where cash flow is the lifeblood of the firm. A monthly payment, even with interest attached, is often the better option than using cash to purchase capital items. It allows the lessee to purchase an expensive item or capitalize the business over a period, thus alleviating the necessity of finding a significant amount of upfront cash.
Pros
A good way to raise cash flow from existing owned assets
Tax efficient – 100% of rental cost may be offset against trading profits for tax purposes (as opposed to interest paid on a bank loan)
A lease contract is often worked over a longer period than a bank loan
Cash Flow for business, especially a start-up will not be affected by massive outlay for CapEx.
Lease payments are tax deductible business expense
It is easier to get leasing finance with poor credit rating
Leasing terms are lower than using another form of capital financing
Lease companies offer flexible terms, such as closed end and open end leases, and balloon payments, etc.
Cons
The asset is rented and therefore never owned by the business
Leasing contract may be more expensive than a bank loan
Leasing, whether it is a car or equipment doesn’t allow for equity build up and is often more expensive over time.
Monthly payments have to continue to be made (according to the initial contract period), and there is always a substantial early settlement charge involved, even if the asset is no longer in use!
Reading the “contract fine print” is of vital importance. Lessees must make themselves fully aware of all the terms and conditions regarding insurance legislation, repairs and maintenance and the most important of all, ‘who actually owns the asset and who owns the lease.’ Often these are two separate companies.
Confusion and ignorance are not an option. Make yourself fully aware of your rights.
HIRE PURCHASE (HP)
Hire Purchase is possibly one of the easiest finance options to understand. You effectively hire a vehicle from a finance company for an agreed period of time
As such a Hire Purchase agreement is one of the most common methods of paying for your new vehicle, typically lasting 2-3 years but it can stretch to 5 years to meet your needs.
You come to an agreement with the finance company about your initial payment (unless predefined by the finance company), your monthly payments and the term of the policy. At the end of the agreement (assuming everything has been paid under the agreement) then the title to the vehicle is transferred over to and you become the legal owner.
As the lender is keeping the ownership of the vehicle until the end of the agreement this gives them more security in the event of payment problems. The lender can also offer you more attractive terms and conditions because they keep ownership of the vehicle until you make your final payment.
HP is a means of buying goods on credit against monthly repayments over a fixed period of time Interest is charged for the period of the agreement and the maintenance of the asset is your responsibility The business does not have legitimate title to the asset until the final instalment has been made
Pros
Spreads the cost of the asset over a period of time
You do not have to pay for maintenance or insurance
Payments are tax deductible
Once you make your final payment you own the vehicle
Convenient straightforward application process
Fixed repayments and interest rates
Additional protection over a personal loan
Payments and term to meet your budget
Keeps existing credit lines free
There is no need to estimate the mileage at the outset
Rebate of future interest if you settle your agreement early
Additional customer protection with regards to the satisfactory quality of your vehicle
Cons
HP may be a more expensive option than a bank loan or overdraft
The goods cannot be classified as an asset of your business
Failure to keep up the repayments may ultimately result in repossession of the asset
The loan is secured against the vehicle, therefore if you miss payments on the loan the vehicle may be repossessed
BANK OVERDRAFT
When you go into your overdraft, you’re getting into debt. An overdraft should be for short-term borrowing or emergencies only. It’s important you manage an overdraft like any other debt to make sure the costs don’t spiral. This guide looks at how overdrafts work, how to cut costs and stop going over your limit, and how to avoid bank charges. An Overdraft is a good solution to use to solve short term cash flow problem or as a standby facility for use in case of need.
An overdraft facility is an agreement by the bank to allow a business to overdraw its account up to an agreed limit. Whilst there will be an initial arrangement fee of 1% - 2.5% to set up the facility the business will only pay interest on the amount overdrawn. The interest rate will vary depending upon your business, size of loan, security available and other factors but may average between 2.5% - 6% above base rate. For small overdraft facilities (up to £25,000) the bank may not ask for security. Overdraft facilities are normally reviewed annually with an annual arrangement fee taken Types of overdraft
Authorised overdrafts: are arranged in advance, so they’re also known as ‘arranged’ overdrafts. You agree a borrowing limit with your bank, and you can spend money up to that limit through all the normal payment methods. There are often fees even with authorised overdrafts. You can find out more below.
Unauthorised overdrafts: these are also known as ‘unplanned’ or ‘unarranged’ overdrafts and happen when you spend more than you have in your bank account without agreeing it in advance. They can also happen if your bank has agreed an overdraft for you but you go over the limit they’ve set. You will pay extra charges and these can mount up very quickly.
Pros
A very flexible way of borrowing particularly for short term cash flow problems
Cheap finance – you only pay for what you borrow
Cons
Overdrafts (as opposed to loans) are repayable upon demand
If an overdraft facility is exceeded the resulting charges can be very punitive
TIP – Many businesses make the mistake of using their overdraft facilities to fund capital purchases leading to pressure on the facility once cash flow becomes tight. Try to separate the medium to long term funding requirements of your business from purely short term/emergency funding requirements.
To learn more about your funding options and apply for business and property finance, please visit our website here.
Written by
Maurice Sardison
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