The alternative finance jargon buster – a guide for SMEs
6 min read
12 May 2016
Some of the best providers of alternative finance are those that communicate offerings as simply as possible – but just in case, here's the key to cracking the jargon code.
The last thing that small and growing businesses need when considering finance options is to be faced with a wall of jargon that makes it difficult for to make the right choice. To navigate through the alternative finance marketplace, some knowledge of the most commonly-used terms may be helpful.
Order book – This is a record of all the orders placed with the business, either electronically or manually. This document is often viewed by lenders and is regarded as a measure of the company’s trading success.
Profit & loss – Profit & loss accounts are usually prepared annually and provide a record of the company’s turnover. Lenders may want to view this when considering an application for a loan.
Debtors’ ledger – The ledger sets out all the customers to whom goods have been sold on credit. This is another document that lenders will probably want to view when considering your application. Depending on how much money is owed to the business, it may be possible to leverage the debt in order to access the finance needed to fund growth plans.
Gearing ratio – This is a measure of how much equity has been invested in the business versus any loans that have been secured by the business to date. A high gearing means there is a high proportion of debt to equity and could affect loan values in some instances.
Adverse credit – This means the business has a bad credit rating. This may be because the business has defaulted on repayments in the past. This could make it difficult to secure finance.
Loan covenants – These are conditions placed on the business by the lender as part of a loan agreement. These covenants can vary considerably from lender to lender but, for example, they can stipulate minimum revenue expectations and set limits for capital expenditure. Defaulting on these covenants can carry stiff penalties and could undermine the management team’s control of the business.
Working capital – This is a term used to describe the amount of capital available to a business at any one time. It is calculated by deducting any current liabilities from the company’s assets. Lenders may wish to take a closer look at how the company is managing its working capital before deciding to provide finance.
Invoice factoring – This is when businesses sell their sales invoices to a third party in exchange for a pre-agreed lump sum which they can draw upon to finance their growth plans or to improve cash flow. Businesses also benefit by no longer being responsible for changing debt and processing invoices.
From community based loans to spot factoring, there are still more definitions that can be explained.
Invoice discounting – In this scenario, a third party organisation gives the business a lump sum based on the value of its unpaid invoices but the business retains full responsibility for chasing debt and processing invoice payments.
Spot factoring – This is when a company raises finance against a single invoice, or bundle of invoices, on a one-off-basis in order to raise cash.
Fixed rate business loan – This is a standard corporate loan offered by most banks. This type of loan is based on a fixed rate of interest over a pre-agreed term or time period.
Community business loan – A number of banks have established dedicated funds to provide finance to social entrepreneurs and community-based businesses.
Donation (or reward) crowdfunding – This is when people invest for purely benevolent reasons or because they believe in the cause. Sometimes rewards are offered to donors, such as tickets to an event, but essentially donors expect nothing in return.
Debt crowdfunding or peer-to-peer lending – This type of lending allows businesses to bypass traditional bank loans. Lenders expect to receive their money back with interest but sometimes they can bring their own expertise or market knowledge to bear to support the business.
Equity crowdfunding – This is when individuals invest in a business in exchange for some shares or an equity stake in the company. Taking this approach, the investor is sharing in the success or failure of the venture. Lenders tend to view this form of finance as a personal investment.
Community share issue – This is a way for communities to come together to use a crowdfunding platform to raise finance for something that will benefit them. A community share issue recently raised close to £600,000 to fund the restoration of Hastings Pier.
Loan to value – This is a lending risk ratio used to assess how risky a particular loan might be. It is based on a calculation of how the big the loan is compared to the value of any asset it will be used to acquire. This ratio is often considered when raising finance to buy property.
John Atkinson is head of commercial business at Hitachi Capital Invoice Finance.