Business And Leadership, Ireland's Business News Service

Even for an established organisation, it is important to keep a tight focus on maintaining an adequate level of working capital. Many businesses raise finance to cover their day-to-day and short-term needs, like bills and wages, from the banks. Short-term finance is also utilised to minimise seasonal fluctuations in cash flow in certain types of business.

Medium-term finance, usually up to seven years, tends to be used for purchase of assets, access to equipment, or research and development, but it also may be used for working capital purposes. Long-term finance or fundraising activities are unlikely to be used to address a temporary cash-flow deficit if one of the other options is available. It is more likely that you would avail of this option if you anticipate a future long-term cash-flow deficit.

At present more companies are finding themselves cash-strapped, according to Nick Linnane, partner at Linnane McGleenan, and needing to raise finance for operational needs. “Construction is a no-go area at the moment, for example, for obvious reasons, so anything that smells of concrete makes people nervous.” And there’s a vicious circle that ensues, he says, with suppliers along the chain unable to get cash in quickly enough to cover their operations. “It can’t be emphasised enough at the moment that cash is king for any business.”

According to Linnane, banks are naturally more cautious about advancing money given recent events, but, above all, they are rightly looking at things more closely than previously. However, a good, honest rapport with your bank should mean any viable business can talk to them about financing solutions for the short and medium term in particular. Some of the options are laid out below.

Before looking for finance from the outside, Linnane does advise that companies look at ‘in-house’ financing. This involves tidying up your own working capital first of all in terms of more efficient debt collection, and ensuring that you are only working with customers who pay. “Those who don’t pay are more of a hobby than a customer, and hobbies are expensive. We would all have customers that don’t pay us,” says Linnane. “Look at your customer list and ascertain whether they are going to pay you or not. If they’re not going to pay you, don’t do work for them. It sounds very simple, but a lot of businesses don’t implement that rule.

“You’ve got to make a decision on this straightaway. We’re all operating on tight margins and if a customer doesn’t pay for six months what you’re paying in bank overdraft interest may be wiping out your margins.”

SHORT-TERM FINANCE

Business overdraft facility

You may be able to obtain a temporary overdraft facility to enable your business to meet its obligations for a short period of time. This is a relatively cheap form of finance as the charges associated with setting it up are minimal and interest is only incurred for the period that your account is overdrawn. However, it is only cheap if it is genuinely a short-term solution, and can become one of the most expensive solutions if not, says Linnane.

“An overdraft facility must only be used for the short term. One practical and cost-effective way it can be used is for stocking up in the pre-Christmas period, then clearing the balance in January as customers start to pay.

“Customers, clients and companies can get into a position where they use this facility on a permanent basis, and that doesn’t make sense as you are paying back very high interest rates. It’s a permanent high-interest rate,” he points out.

Short-term loans

In the event that you cannot or do not wish to take up an overdraft facility, this is another form of finance that is available, where interest is charged on the outstanding balance.

Invoice discounting/factoring

Not as expensive as overdraft interest, invoice discounting can be quite efficient. It basically accelerates your cash flow by turning as much as 80pc of funds tied up in unpaid debtors invoices. The balance, less charges, is then paid to you as payments are received.

One proviso, says Linnane. Ensure that you look closely at the quality of your debtor customers. “A pitfall can be getting finance in this way on an outstanding debt that may subsequently prove to be a bad debt. You then end up paying back the financial institution rather than the customer. If you have a strong debtor’s book, it’s not a bad way of releasing cash. But, again, there’s a cost, so if you can avoid it, do,” Linnane adds.

The principles behind factoring are much the same as invoice discounting, except that the factoring company takes on your credit management, and normally sends out the statements, and reminders to the debtors. The debtor payments are then paid directly in favour of the factoring business. With invoice discounting, the responsibility for good credit management and sales-ledger administration remains with your business.

MEDIUM-TERM FINANCE

Term-loan finance

This is another option to getting your business out of a tight cash-flow situation in the medium term. Rather than taking a loan out over three months, it can be spread out over up to seven years to take the pressure off the business. It can be useful for funding short-term capital items – plant purchase, changing fixtures and fittings, computer equipment and so on.

Hire purchase

For plant and equipment, a hire-purchase agreement can be a good option. It allows you to use the equipment while you are still paying for it; once it is paid down, the equipment belongs to you. Basically, under a hire-purchase agreement, the asset purchased is the security against the finance borrowed.

Leasing

Leasing can be an option if you need to purchase equipment and do not have the capital to spare. You make regular payments to lease or rent the asset from a financial institution or lessor. However, it is important to note that the lessor retains ownership of the asset. So, it is not as attractive as hire purchase from that point of view.

Overall, take into account that there are costs associated with all these forms of finance and comparing the cost of different forms of finance can be complicated.

It’s advisable to obtain advice from your accountant, but key considerations should be:

• Fees
• Period of finance
• Interest rates
• Tax implications.

If your business is strong and viable despite the current woes, and you have a good relationship with your bank, it may be possible to negotiate on fees, interest levels and terms. “Banks are still hungry for business, but they’re hungry for the right type of business with the appropriate financial statements, business plans and cash flows,” says Linnane, so ensure you have all the necessary paperwork in place.

While businesses should explore paying tax efficiently and cleverly, that may be less of a priority today, says Linnane. “In the current climate I wouldn’t be emphasising tax efficiency; rather cash flow should be the main focus. Your working capital is cash at the moment. Cash is No 1.”

Tips for managing your relationship with your bank

This is the time when the investment you have made in developing a good relationship with your bank should pay dividends. You should enlist your bank’s help when reviewing your financing arrangements.

• Keep your bank informed of your position. Communication is vital
• Early and honest disclosure is paramount. Don’t ignore the warning signals
• During any period of difficulty, ask your bank to consider options such as paying interest only for a period; increasing your overdraft or funding facility; or asset liquidation
• Don’t go to your bank at the last minute and expect an immediate solution. Inform them in a timely fashion of problems coming down the line
• Back up your financial position and forescasts with clear and adequate documentation.