30 June 2014

The key to unlocking your cash

Debt doesn't have to be a burden. On the contrary, says Ian Vallely, in the right circumstances it can lighten the load on your business finances by releasing locked-in capital.

The dictionary defines credit as "the ability of a customer to obtain goods or services before payment, based on the trust that payment will be made in the future".

In other words, credit means debt, a word that strikes terror into the hearts of many, especially in the wake of one of the most devastating economic crashes in history in 2008.

In fact, debt is only bad if you can't afford to repay it. Indeed, owing money makes perfect business sense if it oils the wheels of innovation and facilitates growth. So, assuming you have a good handle on your company's finances, the question is no longer whether you should take on debt, but what form should it take?

As well as conventional bank loans and overdrafts, there are several other useful ways to release funding from resources that would otherwise be tied up.

These include asset finance and invoice finance. But what are they and how do they work?

As the recovery takes hold, liquidity is moving rapidly up the business agenda. Significant cash is trapped in the manufacturing sector because of its traditional obsession with the buying of equipment and machinery outright.

Siemens Financial Services (SFS) expects the level of this 'locked liquidity' in the UK to be an eye-watering £10 billion between 2014 and 2018.

Asset finance – a loan used to obtain equipment, machinery and vehicles (typically in the form of hire purchase, leasing or renting) – improves liquidity by avoiding the need to pay cash up front.

For Neil Lloyd, head of sales development at Lombard, this form of finance provides a flexible, affordable and secure alternative means of funding business assets. "The equipment itself stands as security, allowing businesses to use and pay for the asset over a period of time, freeing up budget to use elsewhere, while also providing an additional line of credit.

"By spreading the cost of payments over an agreed term, it means that the cost of ownership can be matched to the life of the asset, or in some cases to the length of a particular contract."

Carl D'Ammassa, managing director of asset finance at Aldermore, agrees that asset finance is increasingly recognised as an effective way to liberate cash that would otherwise be locked in equipment purchase.

As he points out, it is flexible and spreads the purchase cost over an asset's economic life: "An asset finance facility allows you to pay for the asset in instalments so you pay while it supports your business. You can also fix the cost of buying it too."

SFS emphasises the point:?"By spreading capital expenditure over a financing period pre-agreed in a lease or rental arrangement, the need for a large initial outlay is reduced, thereby increasing the funds available for operating expenditure."

In other words, asset finance allows you access to the latest technologies without having to commit scarce capital or use traditional lines of credit.
Besides, it might pay to commit capital to appreciating assets such as property, but where's the business sense in paying outright for depreciating assets – machinery, equipment, technology, vehicles, etc?

SFS puts it this way: "No nimble industrial company wants to find themselves owning previous generation equipment (which they have decided to write down, for example, over 10 years) when a more productive, or more energy efficient alternative becomes available. In this situation, companies that have signed up for a lease agreement, which typically will include an upgrade capability, will have an advantage in the market."

Although asset finance does not make you the legal owner of the asset until all of your payments are completed, says Aldermore's D'Ammassa:?"In order to qualify for asset finance, you must have high quality insurance so you don't have to worry about damage."

Your flexible friend
Lombard's Lloyd sees it as a particularly flexible option: "It can be used for a diverse range of assets, including tangible assets which may range from plant and machinery to office equipment, cars and vans to energy efficiency devices such as biomass boilers. It can also be used to fund intangible assets such as intellectual property rights."

The mechanism to supply asset finance is typically hire purchase (where you pay a deposit and then the balance plus interest through regular instalments over an agreed period) or leasing (where the finance company buys the asset and you rent it at an agreed rate over a pre-determined term). Since asset finance is not repayable on demand, it isn't classed as an overdraft.

Aldermore says almost two thirds of UK SMEs use this form of finance to fund investments, with single transaction lending amounts ranging from £5,000 to £1 million.

With invoice finance, a third party – typically a bank or other financial institution – agrees to buy your unpaid invoices for a fee.

It takes three main forms – debt factoring (essentially a business selling its invoices to a third party), invoice discounting (a confidential type of factoring that allows a business to draw money against its sales invoices before the customer has paid), and asset-based lending or ABL (providing funding against the value of assets in a business, including debtors, plant and machinery, and property).

Damon Walford, managing director for invoice finance at Aldermore, explains: "Invoice financing is a facility enabling you to get speedy access to a percentage of your outstanding invoices. We'll advance an agreed percentage of the value of your outstanding sales ledger so, instead of waiting weeks or months to get paid, you get quicker access to your money."

This form of finance negates the need to take out a loan or overdraft to free up cash. Walford again: "The range of products and solutions under invoice finance can enable businesses to extract value from their unpaid invoices. This enables companies that are high on ambition, but low on capital to meet that 'big order'."

For Colin Muir, head of asset based lending, SME at RBS Invoice Finance, invoice finance is particularly beneficial for manufacturers and distributors, who often have to invest in materials, inventory or technology, months before payment is made, during which time cash flow may be restricted

He says: "Firms can tap into the value of their sales ledger and assets to assist their day-to-day working capital needs. In fact, 94% of respondents in a recent survey carried out by RBS Invoice Finance of over 1,500 companies answered that they knew invoice finance could help grow their business, showing business leaders recognise the huge amount of value tied up in their sales ledgers."

Invoice finance can also support growth. Muir again: "It can be an accelerator for businesses looking to grow and stabilise cash flow. Factoring can free up employees tied up with credit control and ABL, in particular, can provide the working capital to keep day-to-day business strong while you invest in the increasing capacity with new contract wins, for example, and giving the confidence to expand."

Credit where credit's due
Businesses employing nine to 250 employees have given banks an average score of 65% in a government-backed survey of business satisfaction with UK banks. The firms failed to give a five-star rating to any bank for value. However, 17 of the 21 banks rated received a 3.5 star rating or above for credit approachability.

These are the first results from the Business Banking Insight (BBI) survey, commissioned by Chancellor of the Exchequer George Osborne to provide Britain's small and medium-sized businesses (SMEs) with a clear and credible way to judge how their bank compares to its competitors.

Osborne said: "A key part of our long term economic plan is increasing competition and choice in banking and ensuring Britain's SMEs get the best possible service from their bank. This new survey will be a powerful tool for these businesses, providing them with the means to see who's up for the challenge and who isn't."

BBI, announced by the Chancellor last November, went live last month. It showcases the experiences of more than 5,000 businesses and how they rate their banks, with a view to enhancing the trust and transparency between the two groups.

Customer satisfaction levels are shown overall and against the five key factors on the BBI website – transparency, tailored services, value, availability and keeping customers informed.

The programme has support from the Federation of Small Businesses and the British Chambers of Commerce alongside an advisory group that includes HM Treasury, British Bankers Association, Royal Bank of Scotland, Department for Business, Innovation and Skills and the Competition and Markets Authority.

Author
Ian Vallely

Supporting Information

Websites
http://www.abfa.org.uk
http://www.betterbusinessfinance.co.uk
http://www.businessbankinginsight.co.uk
https://www.gov.uk/business-finance-explained/invoice-financing

Companies
Aldermore Bank plc
Lombard
RBS

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