Every company needs a boost to its cash flow or working capital from time to time and for a whole multitude of reasons as a normal part of doing business. Traditionally a bank loan was the obvious route but banks have almost completely stopped lending to SMEs.Enter factoring and unsecured loans. Both are alternatives to traditional secured lending that provide cash-strapped businesses with the cash injection they need, relatively quickly and painlessly. So let’s examine both these options and see which might be the best choice.
This option best suits established companies who need a fast cash flow injection in the short term. Ideal candidates can demonstrate a sales book of sound customers and a good and provable flow of regular payments. One of its advantages is that it can grow in the future in line with the company’s sales growth.
Factoring also provides other options like single invoice (or spot) factoring. That enables a single invoice to be factored on a one-off basis without having to enter into a long-term agreement with the finance service provider. An extended version is called selective factoring whereby the business selects occasional invoices to be factored.
A factoring service company buys sales invoices from a business at a discount from the full invoice value and then realising the profit when the client debtor eventually pays. Usually the factoring company pays between 80% to 90% of the amount due immediately and the remainder when the client debtor pays, less agreed fees and interest. The fee arrangement is by invoice and therefore best suits business with a small number of high value invoices.
Unlike banks, which base their risk assessment around the business applying for finance, factoring services look at the debtor who has been invoiced. Therefore a business with a good proportion of reliable clients will be welcomed, regardless of its own financial status, although directors’ guarantees are likely to be required.
These provide one-off lump sum funding for a business, although they can of course be renewed if required. They can be advanced for as much as 90% of the monthly sales volume and repaid in between 3 to 12 months. Therefore an unsecured load is seen as a very short term instrument but also a “quick fix” because funds can be in the company’s bank account inside 24 hours in many cases.
Interest can be agreed at either a fixed or variable rate and added to the monthly amount that repays the principal to the lender. Because unsecured loans obviously represent a higher degree of risk than secured loans, interest rates are higher as there is no security for the lender.
This lack of security is offset to a certain extent by higher interest rates, smaller loan limits than for secured loans, and shorter repayment durations. This is the very same reason that lenders in the alternative finance market secure advances against assets, such as sales invoices for invoice factoring. It is asset based lending.
Lenders will look at a company’s sales volume, projections, trading history and credit history when assessing an application for an unsecured loan. That will to a large extent govern the size of the loan the lender will advance as well as the interest rate and duration. That means it is an excellent option for businesses with a solid trading history.
Download our free Guide To Invoice Financing, Factoring & Invoice Discounting, which describes these and other short term finance options to fill your cash flow gap.