The recent announcement on the new Basel III capital rules has sparked fear that the availability and attractiveness of company overdrafts could dramatically decrease. So what are the alternatives to an overdraft for a SMEs.
The new proposals will force banks to adhere to a minimum capital ratio of seven per cent, compared to the current minimum of two per cent. This means that banks will have to increase the amount of capital they hold against undrawn overdraft facilities, causing the cost of corporate overdrafts to rise and impacting SMEs in particular. Her are the alternative funding options:
Factoring allows a business to raise money by assigning its outstanding invoices to a lender, who will advance a percentage of the total (usually around 80 per cent) immediately. The lender takes control of the debts and chases payments without reference to the business. There are restrictions on the debts which may be taken into account for the purpose of factoring; typically debts over three months old, overseas debts and consumer debts (as opposed to business-to-business debts) will be discounted for the purpose of calculating the percentage available to the business. For smaller firms, which may have fewer resources and systems for efficient credit control, handing over the administration of book debts to the lender is an advantage. However, the business loses control of how customers are chased for payment and the reputation of the business and relations with customers may be harmed.
Similar to factoring, invoice discounting also allows a business to raise money against its outstanding invoices. The difference is that the invoices are not legally assigned to the lender but are retained by the business. The advantage of invoice discounting as compared to factoring is that the business retains control of its own book debts and continues to collect in payments itself; customers are therefore unaware of the arrangement and there is less risk to the reputation of the business. However, a smaller percentage of the outstanding invoices will usually be advanced than in the case of factoring and invoice discounting is generally only available to businesses with a turnover of at least £1m.
Asset finance describes a loan secured over assets of the business. It is particularly suited to manufacturers, distributors and retailers which deal in high-value assets and a large percentage of the value of the asset is often advanced, ranging from 80 per cent to 100 per cent. A variety of loans are available, with fixed and flexible repayment terms offered by many lenders. Interest and depreciation of the asset are tax deductible which can make this an efficient borrowing vehicle for many SMEs.
Leasing and hire purchase
Where a business needs to acquire large assets, such as plant and machinery, leasing or hire purchase can be an alternative to purchasing. Hire purchase involves making installment payments over a set period. Legal title to the asset remains with the hire purchase company until the final payment has been made, although the business will usually be responsible for maintenance and repair costs.
Leasing is generally more suited to smaller assets such as office equipment. The equipment is rented for a specified period. Legal title is with the leasing company, which is often also responsible for service and maintenance.
Deferred payment terms
Where the business involves the regular purchase of goods or services, deferred payment terms can sometimes be negotiated with suppliers. The supplier effectively offers an interest free loan to the business for the period between invoicing and payment – 60 or 90-day terms are common, although businesses should be aware that the cost of this "credit" may have been built into the price of the goods and cheaper options may be available elsewhere.
David Few is a partner and head of the corporate team at Blandy & Blandy LLP.