A simple guide to small business finance
Recent research by Australia’s leading small business magazine My Business has identified that the biggest pain points for Australia’s SME’s are attracting new clients, followed by cash flow and staffing. Interestingly, when asked which areas of finance are most important to their business, 78% said cash flow, 31% said they required finance to grow their businesses, and 10% said vehicle and equipment financing.
So whether it’s cash flow or capital – small business needs money! And commercial finance is designed to help small businesses manage their short term cashflow and operational needs and business growth needs.
Here we take a look at the range of business lending options that suit different business needs.
Small Business Lines of Credit and Business Overdrafts
Businesses often use lines of credit and overdrafts for short-term capital, or as a source of cash flow to keep operations running smoothly.
A line of credit is an accessible and flexible long-term arrangement between a business and a lender, where the business can access funds up to an approved credit limit. The business may borrow all or part of the money at any time – up to and including that limit and only owes interest and makes repayments on the amount used.
An overdraft is also a line of credit, but is attached to the businesses existing transaction account. In essence, the financial institution allows the business to overdraw their existing business account up to an approved limit – usually only being able to access the overdraft after their own funds have been used. The lender charges interest on the overdrawn amount.
Bank term loan (secured or unsecured)
A bank term loan is a medium-to-long-term loan option commonly used for purchasing equipment or covering business start-up costs. It involves borrowing from a lender and making regular repayments over an agreed period. It allows a business to choose from fixed, variable, split rate or interest-only loans and to borrow a larger sum over a longer term, with lower interest rates, with the loan term often being matched to the life span of the underlying asset.
A mortgage loan can be used to cover most of the upfront costs of purchasing a property for your business. The property is then used as collateral by your lender until the business is able to repay the loan amount and the incurred interest. It allows a business to choose from fixed, variable, split rate or interest-only loans and may offer features such as redraw facilities and no-penalty early repayment.
Commercial rate loans
Also known as business markets loans. This is where a business borrows a single loan amount, which can be spread across a combination of components, such as floating rates, fixed rates and cap rates. This helps to protect against interest rate movements.
Cash flow finance
This provides a way for a business to get cash before their customers actually pay. There are two common methods used by businesses:
- Invoice discounting is where a business accesses a percentage of their debtors’ unpaid invoices through their lender, and the lender uses the debtors as security.
- Invoice factoring is where the lender assumes responsibility of the business’s debt ledger and chases payments on its behalf.
Both attract a fee and are designed to service the cash flow gap between outgoings and income.
Asset finance is primarily used by business to purchase equipment and vehicles. There are a range of different loan structures to suit;
Chattel mortgage: Also known as an equipment loan. A business borrows money to purchase an asset. The business owns the asset outright, but the lender uses the asset as security until the business repays the loan. This frees up capital and ensures the business has security against the loan.
Hire purchase: The lender purchases the equipment and rents it to the business. At the end of the term, assuming all payments are made, the business takes ownership of the asset. This is a popular way to spread the cost over a period of time.
Finance lease: The lender owns the equipment and the business pays a hire fee for use. In some cases, the business may be able to purchase or refinance the asset at the end of the set term, which gives flexibility.
Operating lease: The lender owns the equipment and the business pays a hire fee for use. The business does not take ownership of the asset. The costs are deemed operational expenses.
Novated lease: A Novated Lease involves a three-way agreement between an employer, an employee and a lender. The Novated arrangement involves the employee leasing the vehicle directly from the lender. The employer will then agree to deduct lease rentals from the employee’s salary during the term of employment and to pay the rentals directly to the lender. The employee has the use of the vehicle for personal purposes.
More information on small business financing can be found here
Anthony Landahl | Equilibria Finance
This is for general information purposes only and does not constitute advice. With all of these options there are a number of considerations outside the scope of what is covered in this article that you need to understand to ensure your personal circumstances are taken into consideration.