The financial world has been dominated by big banks for decades, but the landscape is changing. Public opinion of banks has deteriorated and their processes and technologies have been revealed to be outdated. Meanwhile, new entrants have challenged the assumption that all major financial transactions must go through a bank. Faced with increasing demands on their time and money, businesses are looking for real solutions to their problems, no matter the source.
One of the most common forms of business finance is the standard loan, used for any number of purposes from working capital to diversification. Post- 2008, the lack of available funding created an opportunity which peer-to-peer (P2P) lending seized.
This innovative form of financial technology allows lenders to choose who to lend their money. Technology enables the complex calculations and money handling to be carried out automatically. For the most part, P2P is online-only and in keeping with its digital environment has offered significant improvements in transparency and speed as well as simply having the ability to lend to companies when banks can’t.
While it began life with grand plans for revolution, the explosive growth of P2P lending has since tailed off. It has produced some much-needed advances in financial technology and proved that commercial lending could – and should – be far more transparent. Yet it did not change the basic nature of the product: for the borrower, a P2P loan is still a loan.
Whatever the source, loans are issued based on an analysis of the company’s situation and its trading history. Companies lacking any trading history, or whose plans outscale its current capabilities, are rarely able to access loans. The potential rewards may be higher but so are the risks and banks, which are dealing with other people’s money, cannot afford to take those chances.
Instead, raising equity investment allows entrepreneurs to pitch direct to high-net-worth individuals or groups. Venture capitalists have the expertise and time to conduct their own due diligence and make their own decisions. Their experience with start-up companies is also often invaluable to the entrepreneurs. Equity investment at seed or venture stage trades upfront access to cash for ownership of a portion of the company.
When investing directly in this way, it takes a lot of money to build a diversified portfolio. Equity-based crowdfunding is the latest entrant into the crowdsourced-finance segment, and opens up the field to more investors by enabling them to make much smaller investments. Suddenly it is possible for people to invest across a multitude of early-stage businesses without having large sums to invest. Crowdsourcing makes it possible for would-be businesses to pitch to hundreds or thousands of potential investors without the months of legwork and networking this used to entail.
The challenges that businesses face today range from generating back office efficiencies to better cash management. The days of cash-rich businesses floating on months’ or even years’ worth of available capital are over, but keeping a tight rein on cashflow is tough when many of the influencing factors are outside the control of financial managers. The first port of call for many, the bank overdraft, is no longer as universally and easily available as it once was; fewer overdrafts are being authorised and those already existing are seeing limit reductions.
Unfortunately, this pressure on cashflow has resulted in some companies simply transferring the pressure to their trading partners – either forcing smaller suppliers to extend their credit terms or simply not paying their own customers on time. The problem was endemic long before some high-profile cases turned public opinion. However, government commissioners and voluntary business practices aside what’s clear is that there is a problem in need of a financial solution: quick and reliable access to short-term working capital.
Invoice finance (factoring) allows companies to immediately access the money due from their outstanding invoices, making that money owed available earlier than expected. This is beneficial, as even with good payers the exact payment date cannot be predicted, and when there are disputes or queries payment can be delayed indefinitely.
There are two forms of invoice finance. Invoice discounting provides access to cash tied up in a business’ outstanding invoices based on its whole turnover and it’s particularly beneficial to big enterprises. Traditional factoring is geared towards those businesses that are smaller and need assistance with credit control. However, some larger firms opt for this type of facility as they see the benefits in outsourcing their credit control functions.
Invoice finance has not gained the traction that other forms of finance have. This is down to the fact that it is only suitable for businesses that are trading on credit terms and with straightforward terms of trade. Some firms do offer the ability to fund debt of a contractual nature. These types of facilities are often relatively inflexible.
The next generation of invoice finance is invoice trading, which has evolved as a result of new market entrants responding the need to provide access to funding quickly and simply. With invoice trading companies of any size can sell individual invoices, generally through an online portal. They can receive cash quickly and at competitive rates. This makes it more reactive and enables companies to use it to quickly access capital when unforeseen circumstances put pressure on cashflow.
The problem with invoice trading for the funder is that their client is the one selling the invoice, not the one who is due to pay the invoice. This means a higher level of risk which lenders must account for when making their lending decisions. Good online platforms are those that have taken the risk management culture from the invoice finance industry and carried it forward, providing funders with the confidence they require.
Financing the supply chain
The other half of the receivables finance challenge is when the company being invoiced doesn’t have the cash to pay for it. Delays with payment are not always a question of malpractice – sometimes a customer just doesn’t have the working capital available to pay their suppliers, for example due to late payment or defaults by their own customers.
This problem can be exacerbated when the supply chain is long and complicated with many transactions or multiple suppliers. When tendering for large projects, for example in the construction industry, companies must be able to maintain confidence that their suppliers and their suppliers’ suppliers will be able to deliver consistently.
Large firms have a vested interest in maintaining the healthy cash flow of their customers. They can take steps to mitigate their own risks by proactively tackling the risks of their smaller trading partners.
Supply chain finance (SCF) is a working capital solution, which can be used to extend a company’s payment terms. Suppliers can work with funders to put a facility in place which enables their customers to flexibly access funds.
In some instances; the suppliers’ customers access the facility, enabling them to pay selected invoices early without impacting on their own cashflow. They may also have the opportunity to negotiate early payment discounts with their suppliers. In other cases, suppliers choose to receive funding against unpaid invoices and pay for the facility, enabling them to give their customers extended payment terms.
SCF can be an innovative funding solution for many firms. It does not require security which means that it works seamlessly alongside other types of finance.
Borrowing against assets
While normal business loans can and often are used to purchase assets, the creditworthiness of the business is the final decider and can be a limiting factor. This is particularly unfortunate in cases where, for example, significant capital expenditure is necessary to turn the business’ fortunes around. Asset finance lends money based not on the historical performance of the business but on the cash value of the equipment.
Asset finance can be used as a quick way to get funds by securing them against existing equipment or property. This has often been thought of as a last resort, but for businesses with assets this can be a smart way of accessing finance more cost effectively than with a standard loan.
Asset finance can also be used to purchase new equipment, often through some form of lease-hire arrangement. This spreads the cost of the equipment over months or years in the same way that a loan would, but the difference is that in the event of default the lender can simply repossess the equipment rather than putting the company itself at risk.
It’s no longer the case that businesses have to go to the bank to find finance. There are a range of alternative options available tailored to different company circumstances and their specific needs. By using the right finance for their requirements, businesses can keep their costs down and make financial management simpler.
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