Short Term Finance
However carefully you manage your business, the reality is that small businesses may face the challenge of acquiring short term finance in order to meet payment obligations.
Fluctuations in cash flow can have a severe impact on small companies and their output, so understanding how to manage this is crucial to the success of a business.
Why Is It Needed?
Short-term finance may be required if there is an interruption to the usual cash flow of a company. If client payments for goods or services are not made within the agreed schedule, this can have a knock-on effect on your company, leaving you without sufficient funds to cover your usual overheads. Alternatively, short-term finance might be required in order to fund the purchase of stock to cover an unexpectedly large order when working capital is needed very quickly.
What Options Are Available?
There are different types of short-term finance available, including overdrafts, short-term bank loans, trade credit and invoice financing. An agreed overdraft facility will allow you to make payments or withdraw cash up to a certain agreed limit. This is usually subject to an interest rate, and whilst it is a simple and easy-to-organise option, companies may struggle if the facility is suddenly withdrawn by the bank.
Short-term bank loans are subject to much less rigorous and lengthy agreement processes than longer ones and provided that you can demonstrate how and when you will pay the money back, can be a good option if a substantial outlay is required. However, security for the loan is usually still a requirement, even with short-term agreements.
Obtaining trade credit from suppliers allows you to purchase materials and pay for them at a later date, which can be extremely useful if you have a large order to fulfil. Bear in mind that you may then miss out on any discounts the supplier is offering and might also have to provide a standby credit letter from your bank as a payment guarantee.
Invoice financing can help improve your cash flow, providing you with access to cash tied up in your outstanding invoices by unlocking the majority of their value the moment they are raised. Invoice financing agreements, including invoice discounting and invoice factoring, can be a valuable facility for small businesses, and are often described as being more flexible than bank loans or overdraft facilities. However, invoice financing providers will still check your accounts rigorously to establish if you meet their qualifying criteria, and agreements can be difficult to end. You may have to give up to three months notice and all monies must be paid back to the provider before your business is released from the agreement.
How Can You Avoid Needing Short-Term Finance?
The downside of short-term finance is that typically it is subject to high interest rates and banking fees, which can have a significant effect on profit margins. Consistently relying on this type of funding can be a very risky strategy, leaving your company vulnerable if your short-term finance is suddenly withdrawn.
A better option is to try to avoid using short-term finance as a solution unless absolutely necessary. Keep on top of payments, making sure that your outstanding invoices are paid promptly. If clients consistently pay late, you may need to consider whether their custom is sufficiently valuable to your business.
An accurate cash forecast is also a valuable tool in identifying potential short-term cash requirements and your accountant should be able to assist you with this. If possible, try to build up a small reserve of funds in order to accommodate sudden financial upheavals such as a large order or the bankruptcy of a client. Having an overdraft facility in place before a crisis strikes can also be reassuring.
Whilst ideally companies should avoid relying on short-term finance to smooth their cash flow, inevitably there are times when funds are needed in a hurry. Options such as trade credit, invoice financing, or a short-term loan can help a business to continue to function with their daily operations until their finances are more stable.
If you would like more information on any of the short-term finance options available, or advice on how you might avoid the need for it in the first place, call Allsquare on 0131 343 1510.