Think Your Business Needs Finance? – Part 1
Released On 15th Nov 2022
Let’s talk about cash in your business. As a business owner, there may be times when you think you need to raise finance. This is especially true when cash is tight or starts to dry up. However, there is lots to consider when borrowing money; such as the additional costs and risks to your business. We recommend you look at alternatives before you commit to any borrowing. In this blog, we will cover why you need finance in the first place, what your best options are and the costs and risks of borrowing finance.
Why Do You Need Finance?
You may need finance for working capital; the money you need to run the day-to-day business, such as stock, materials, wages and transport etc. It could involve investing in new equipment, property or infrastructure. It could be paying for research and development of new products, marketing and sales, or to cover a downturn in the business or a specific project.
Whatever finance is needed, it should be matched closely as possible to the period that you need the finance. For example, with working capital it is likely you’re going to need it for quite a long time. So maybe consider a long-term loan, equity shareholding, or maybe even invoice discounting.This is especially good when you give credit on your sales.
When looking to buy a new vehicle, consider if you want to own or hire the vehicle (there are a number of options such as hire purchase, lease purchase or contract hire). Also think about whether you want the vehicle put through the business (i.e. company car).
You should match the finance to the length of the time that you want to keep the vehicle, or other chosen assets. It is also important to look at how your interest rates and the costs match your future cash position and ask yourself if you can comfortably afford that finance.
The Costs and Risks of Finance
Taking on finance brings both cost and risk. Firstly, you will have to pay interest. Both interest rates and repayment terms will vary on the product you choose and the perceived risk of your failure by the financier.
With the recent political and economic turmoil – the government, tax changes etc. – the markets are predicting that the base rates will rise to about 6% in 2023, whereas 3 months ago the base rate was closer to just over 3%.
This means the cost of borrowing has significantly increased and the more you are seen as a ‘risk’ to financiers, the worse terms you’ll receive. For example, a ‘good risk’ will be 1% – 2% over base rate, whereas a poor risk could be 20% – 40% over base rate. This would mean the cost and the length of the loan will be much higher, with interest often being much more than the initial borrowing.
How to Position Your Business as ‘Low Risk’
Financiers always consider a business a ‘good risk’ (and are more likely to provide them with finance) when:
- They have confidence in the management
- The business is profitable
- The business has good security, like a property asset.
Up-to-date management information, accounts and forecasting is key, giving financiers the confidence that your business has longevity and stability. If you have made a loss and are now going into profit; showing your future profits and the reason behind your situation to a financier will help you secure better terms.
Future projections showing how you can afford the repayments is key to help demonstrate that you know how to run the business.
What about any other risk for Company Directors?
Security is often required, and if the business is seen as risky (i.e. hasn’t got enough security in property, assets, etc.) they will include the requirement for a Director’s Personal Guarantee. This means that if the business is unable to repay the debt, the Director will be asked to pay it back. This could mean that the Director’s personal assets, including your home, could be at risk.
It’s important to note that unlimited guarantees could be in place for years to come, so try and put a cash limit and timeline on them. For instance, suppliers now ask for guarantees. If, today, you’re getting something from Bradford’s at £5,000 a month, in 30 years time this could be £50,000 a month and you could have sold the business by then without even be aware of the increased cost. Sp always understand what you’re getting into with guarantees.
To recap, you need to fully understand if the interest rate offered is good for your business and whether your security is acceptable, and what happens if the business fails to repay the loan.
In our next blog post, we’ll look at the alternatives to borrowing as well as a worked example.
