Some of the first options for funding that Small to Medium Enterprises (SMEs) will consider when in need of funding are business loans and overdrafts. Studies have revealed however, that about 50% of SMEs are often met with challenges when it comes to accessing financing with banks as they would normally mostly consider their credit history, something that most Phoenix, high-risk, new and small businesses lack.
If in fact banks do offer short-term loans to these businesses, the challenge thereafter is determining the nature of the businesses. If inaccurately determined, the terms of the loan may be inadequately adapted to the business’ needs that are brought about by rapid growth. Suffice it to say, traditional loans have, for a while now, failed to fully address the needs of such businesses, thus giving rising to other sources of funding such as factoring and invoice discounting for operating capital or long-term investments.
This is an in-depth look at the benefits and pitfalls of a business loan when pit against invoice discounting.
- Invoice Factoring
- Benefits of Invoice Finance
- Invoice Finance Pitfalls
- Unsecured Loans
- Benefits of Business Loans
- Business Loans of Pitfall
Invoice factoring
This form of funding is best suited for businesses with a steady stream of reimbursements from trustworthy patrons but could use a short-term cash injection. Invoice factoring can adapt to a business’ needs and also align itself to the growth of its sales. Businesses can also opt of a varied range of invoice factoring such as “spot financing” that offers financing based on only one invoice, this gives businesses the ability to access short-term financing where needed. “Selective factoring” is yet another option. It allows businesses to pick the invoices that they are willing to sell to factoring companies.
Companies that offer businesses invoice factoring will often buy unsettled invoices for a percentage less than the actual amount that the invoice is worth. Then they will realise their purchase amount along with a profit upon payment of the invoice. Invoices are often bought at 80% – 90% of their quoted amount, which is paid out over two intervals, with the first instalment paid within 24hours of purchasing the invoice.
Businesses will only receive the second half of the funds from invoice factoring companies once the invoice has been paid, it is on this instalment that invoice factoring companies will deduct their service fee. Invoice factoring therefore is suitable for businesses with a few invoices of large amounts due to the service fees that are charge to businesses. The funds raised from invoice factoring companies are derived from the business’ calibre of customers as opposed to banks that base their credit history or impeccable trading records. While businesses may need a written recommendation from companies that they have had previous dealings with, attaining funding through invoice funding is achievable with a valid bank statement and a record of trustworthy customers that patron the business on a regular basis.
Benefits of invoice finance
What is perhaps favoured by most businesses is the fact that invoice financing yields 90% or even 100% of their invoice amounts and the funds are made available within the same period of time that the invoice is sent out. Factoring, in particular, is highly instrumental in enhancing the business’ revenue through credit management and collecting debts which could result in swift payments from customers. What is all the more attractive to businesses is the fact that invoice factoring offers the option of a revolving loan allowing for the ease of the loan to move in accordance with the business’ sales figures.
Invoice finance pitfalls
It used to be that Small and Medium Enterprises (SMEs) would forego invoice discounting as a means to raise funds as they would have been expected to give up a substantial number of their invoices to the invoice finance companies. Nowadays businesses have the option of a number of invoice finance products at their disposal. These include selective invoice financing that gives businesses the option of selecting which invoices they wish to surrender in exchange for funds.
With this in mind, it is important to note that businesses that have opted for invoice finances need to ensure that they practice impeccable in-house administration whereas the same is not required with a business loan. Failure to do so may lead to future financial difficulties that could be hard to sort out.
Unsecured loans
This type of loan is suitable for businesses that wish to secure funds for a particular project or event that will not be repeated. This therefore means that it is best for businesses that do not necessarily need a loan that would fluctuate with its sales growth. Be that as it may, the loan provider will still make provisions for the loan to be extended if need be or give businesses the leeway to re-apply for yet another loan. Businesses can get a loan amount of up to 90% of the sales they generate on a 30-day period and can enter a repayment period agreement of anywhere between 3 to 12 months. Funds are made available within 24 hours of application approval, which is a characteristic that unsecured loans share with invoice factoring.
Businesses will pay the loan amount in monthly increments and interest will be charged at a set percentage as per their contract with the lending company. Unsecured loans often charge higher interest rates as compared to secured loans due to the fact that the businesses that the loans are awarded to are deemed high risk businesses. This means therefore that the smaller loan amount given out over a shorter time span coupled with a high interest rate will allay any security concerns. It is for reasons such as security concerns that financial service providers such as invoice finance or asset-based lender will need collateral from the business.
Businesses would need to produce a trading history, a growth forecast and credit history in order to be considered for an unsecured business loan. These will help determine the loan amount, interest rate and the loan repayment term. An unsecured business loan is still considered a better option for businesses with a great trading record and it is especially favourablefor the fact that business’ assets would not be lost.
Benefits of business loans
Short-term business loans are often at the top of the priority list for business owners to consider when sourcing funding, so they will instinctively approach the banks before considering any other option for funding. Businesses should note that banks will only approve a business loan application if the business has a good credit history and a feasible business plan. Having said that though, businesses can enjoy a fixed interest rate (even though it would be higher than normal), thus ensuring that the repayment amount will remain unchanged for the period of the loan repayment term.
Pitfalls of business loans
Business loans tend to be rigid and expensive hence banks will make loan pay outs in lump sums as per their contract with the business. This therefore means that whether the loan was too much or too little for the business’ needs, it would be difficult to rectify the loan amount.