11 July 2016

Lines of credit

Most people care little for money except counting their own. But in business it literally pays to gain a thorough understanding of your financial options. Ian Vallely investigates two credit sources that could help kick-start lending to UK manufacturing, a sector with a habit of self-funding

Smackeroonies, moolah, dosh, crispy wonga, spondulix, wedge, lucre, readies – the synonyms are seemingly endless. Whatever you call it, though, money remains the lifeblood of every commercial business. Companies measure their performance by how effectively it’s invested and their success by how much of it they accrue.

There is, however, a fundamental paradox at the heart of money: many people are passionate about making it, but completely indifferent to how it works. They find it confusing and even boring to talk about the mechanics of finance, and completely fail to understand how money – or, more accurately, credit – can be used to ease the path to business growth.

This is a mistake on two counts. First, the right sources of credit give you access to a steady flow of cash and the working capital to run your business efficiently.

Secondly, finance provides the flexibility necessary to make good investment decisions. It can, for example, help you negotiate discounts with your suppliers, increase your buying power and enable you to seize new market opportunities.

Two sources of credit are particularly useful for manufacturers disinclined, or unable to self-fund – invoice discounting (ID) and asset finance (AF).

ID allows a business to draw money against its sales invoices before the customer has paid. It is a form of short-term borrowing often used to improve a company's working capital and cash flow, which makes it useful if you sell products to other companies on credit, or hold high levels of stock.

AF involves using balance sheet assets to obtain a loan or borrow money whereby the borrower provides a security interest in the assets to the lender. It usually means paying a regular charge for use of the asset over an agreed period of time, thus avoiding the full cost of buying outright. The most common types of asset finance are leasing and hire purchase.

ID used to be regarded as a complex product for niche requirements, but that’s not how Lloyds Bank sees it. David Atkinson, the bank’s UK head of manufacturing, explains: “Invoice discounting enables a business to access up to 90% of the value of invoices that have been issued, but not yet paid by its customers, typically within 24 hours.

“It means the business doesn’t have to wait 30, 60 or even 90 days to get paid and it is confidential, so customers will never know of the bank’s involvement. Crucially, it enables a business to protect its cash flow and grow its working capital in line with its sales.”

Chris Hawes, HSBC’s UK head of transaction risk management for global trade and receivables finance, adds: “Alongside the cash flow benefits, clients can also opt to protect their invoices against non-payment, something that can be of particular benefit when trading with new customers, or those in unfamiliar markets.”

And, as Terry Wolfendale, national head of sales at RBS Invoice Finance, points out: “Having access to sufficient working capital is vital for companies operating in a recovering economy. It can have a significant effect on an organisation’s success, providing the liquidity needed to grow, adapt, complete acquisitions, or to simply help to manage day-to-day trading requirements.

“Manufacturers can experience extreme seasonal fluctuation in orders and payment, but they still have to run plant, upgrade technology, and invest in new materials and inventory year round. This can place high demands on cash flow so it is important to have finance that helps bring stability to this cycle through access to working capital.”

Asset finance is a second credit option that is proving increasingly popular. Industry body the Asset Based Finance Association says the overall amount of funding provided to businesses through asset-based finance – which includes invoice finance (releasing cash currently tied up in outstanding customer invoices through invoice discounting or factoring) – rose by £260 million in the past year to stand at £19.7 billion at end of December 2015.

Meanwhile, the Finance and Leasing Association predicts AF will grow 10% in 2016.

Ian Isaac, head of Lombard, says some manufacturers continue to use cash, “but there’s a growing understanding of the role of asset finance techniques such as leasing and renting, which is to unlock liquidity in a business and preserve capital”.

He also identifies other key benefits: “It frees up cash that can be invested in other business priorities such as research, marketing or staff training. Using asset finance can also mitigate risk of ownership and offer flexible contracts to fit business needs, while fixing the cost of the payment.”

And AF allows a business to spread the cost of payments across the contract term. “The business generates revenue from the equipment while also providing an additional credit line to complement existing cash resources and bank credit.”

Lloyds Bank’s latest Business in Britain report – a bi-annual survey gathering the views of more than 1,500 UK businesses – reveals that 22% of manufacturers used their overdraft as a source of finance in the last year, followed by business loan, hire purchase and invoice finance, each of which was used by 17% of respondents.

There’s a growing awareness and understanding of AF among manufacturers, says Atkinson: “It is a way to buy assets without taking out a conventional loan and… [it avoids] big one-off payments for the extra machinery, or equipment the business might need to grow.

“Asset finance helps raise finance on the high levels of inventory typical of manufacturing businesses. As a cost-effective alternative to borrowing, it provides fast access to working capital and frees up funds tied up in inventory, plant and machinery.”

HSBC’s Hawes agrees: “Asset finance is becoming more popular as it maximises the value of all of a client’s assets to optimise their working capital position, or, for example, to help fund an acquisition. These facilities are also becoming more popular among the accountants, advisors and private equity houses that support transactions in the manufacturing sector.”

In the latest Lombard Attitudes to Business Investment Survey conducted in January 2016, around 74% of manufacturers said they were familiar or very familiar with AF, with 22% slightly familiar; only 4% said they were unfamiliar with it.

However, says Isaac: “We also know from our research that the term ‘asset finance’ is less well-known than the products that make up this type of funding. The survey demonstrated that when we used terms such as ‘hire purchase’ and ‘leasing’, businesses had a much higher awareness. So we know that there is a need for the AF industry to do more to promote the term and to raise awareness of the benefits this form of funding offers.”

Nonetheless, AF still funded nearly a third (32%) of UK investment in machinery, equipment and purchased software last year, totalling almost £30 billion.

Investment has been a fundamental part of the UK recovery process and has had a vital role to play in the revival of manufacturing. Isaac puts it like this: “In a competitive global market, UK businesses need to be ahead of the game in equipping themselves with the latest technology in order to improve levels of efficiency and productivity.

“This continues to be the case and many manufacturers are continuing to invest because they recognise that staying still could be damaging.”

Chris Beck

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