Short-term Funding Options To Build Your Business

Short-term Funding Options To Build Your Business (Part 1)

Know What You Need Before You Throw In A Request

Businesses seek funding assistance basically to enable them do more business than their internal resources can support. That is precisely the essence of leverage: the empowerment to accomplish more than would otherwise be possible. Borrowing for legitimate business objectives, designed to enhance the operational capacity of the business, could accelerate the growth of your business, if properly structured. Needless to say that reckless or unstructured borrowing could, to the contrary, easily asphyxiate your business and spell its demise. You therefore need to borrow wisely. A good starting point is to define your requirement and determine what facility would best serve your purpose. Short-term borrowing, for a purpose that requires long-term finance, can easily create a funding crises for the business. That's why you need to know when to borrow short- or long-term. You need to judge what specific facility type you require. While your banker can guide you in making choices, having a good understanding of how it works will definitely improve your overall results. Here's a guide to short-term funding options that banks can provide to your business.

Facility Options To Meet Specific Needs
A short-term credit facility is one which has a tenor not exceeding twelve months. The tenor is the life span of the facility, meaning that it must be redeemed/retired latest by the expiration of that period. In principle, an understanding and supportive bank can structure a credit to fit into your specific need. Given that such rigour may not often attend the work of the credit officers, the next best thing is to fit you into an existing credit product. This short-list of major short-term credits common in the market should have something that will meet your need.

1. Overdraft (O/D)
This is perhaps the most widely known short-term credit. An overdraft line is meant to service working capital requirement. Working capital is the funding you require for trading and operational purposes: purchasing inventory, meeting marketing, administrative and other operational costs, etc. Purchase of equipment and other fixed assets will not fall into this category. An overdraft line is usually backed with a collateral.

The overdraft line is a facility, provided by the bank, allowing you to draw beyond your own fund in your account, up to the limit specified in the approval. If you have a current balance of N100,000 in your account and an overdraft line of N500,000, it means that the bank will honour a cheque for N600,000 drawn on your account. Why? Because they have already committed to paying up to N500,000 above whatever own balance you have, within the period of validity of the O/D line. In effect, an O/D line will have a limit (N500,000 in our example), a tenor (period of validity) and a rate (you have to pay interest). Note, however, that interest will only be charged on your actual debit balances. If you overdraw your account by N250,000 in our example, interest will be charged only on this amount, notwithstanding that your approved limit is N500,000. Interest is also charged on a day-to-day basis. The import of this is that you can substantially moderate the interest charge on your account just by being creative. Let me explain. If you overdraw your account by N500,000 (to limit) this morning to lift products from your supplier and your are able to sell them or other goods to raise N500,000 during the day, you will pay interest on N500,000 if you pack the sales proceeds overnight in your safe. If however you lodge up to N500,000 into your account, the account will not be overdrawn by day-end, implying zero interest charge for the day. You have used the bank's money interest-free for that day! So, if you have a moving product line, an O/D will give you a boost, at little cost. If you have frequent funding gaps, especially if short-lived, an O/D line will just absorb that strain and allow a smooth flow of your business.

A final word. An overdraft is, in principle, repayable on demand. This means the bank can call up the outstanding amount at any time, but this is fairly rare. Just bear that in mind but it shouldn't stop you from raising funds for your business when you have to.

2. Temporary Overdraft (TOD)
This is not really anything different, but given its popularity in market locations, it has merited separate mention. A TOD is an overdraft that by its nature does not go through all the rigours or conditions of a regular O/D line. They are usually approved by officers at a lower level (usually senior branch officers), have lower approved limits and are usually of very short tenors (less than 30days). They are applied to tiding you over a very short-term funding requirement. Often, it's the account performance and integrity of the customer that count more, with relatively weaker or no security being taken by the bank. One downside to note is that the interest cost of using a TOD will generally be much higher than when you have a regular O/D line.

3. Short-term Loan
A loan can be for a period not exceeding one year which classifies it as short-term.

Unlike an overdraft, the amount of a loan approved for you is disbursed fully to you or as requested by you. Even when the terms of the facility spell out a phased disbursement, each tranche will be disbursed when due. The implication is that if a disbursement is made, say by crediting the sum into your existing account (and correspondingly creating a loan account that takes your debit/indebtedness) it will not matter if you don't draw against it for some time. The loan is already disbursed to you and interest will be running on the full amount. Repayment is usually by specified periodic installments (say, monthly or quarterly). An approved loan will have a term (the period over which it is retired), a repayment plan (you pay specified sums at specified dates, along with interest or else be in default) and rate of interest. So while an O/D line will not impose an obligation to regularise (pay up) the account until its expiration, a term loan has compulsory milestone repayments.

A loan will therefore be applied to a specific requirement, unlike an O/D line which provides a general accommodation. A loan can be used to acquire machinery, for instance. Take a short-term facility only when the business has the capacity to generate the cash flow to meet the repayment obligations over that short term. You bank will require a security for this kind of lending.

4. Consumer Finance
Again, this is nothing very different, but in view of its growing application, it deserves highlighting. Consumer credit is provided by banks to individuals, professionals in practice and small businesses to fund asset acquisition and some times for investment (say for purchase of company shares). Assets bought could be for domestic or office use and the facility could be for a short tenor. The key feature to highlight here is the flexibility you may enjoy in terms of collateral: usually, the acquired asset is the security for the credit. So, when you need, say, computers for your office, a consumer/asset finance may just be it.

5. LPO/Contract Finance
Because of our 'contract' syndrome, Local Purchase Order (LPO) finance is a relatively well-known product. Contract finance too is of the same family. LPO finance simply finances LPOs, enabling a person or business that has been awarded a purchase order to supply certain products to the issuer of the LPO to raise money to get the job done. In similar vein, contract finance is provided to support the execution of a contract. To successfully source LPO finance from banks or other lending institutions, you must ensure that the issuing authority is reputable. Generally, only LPOs of top-grade companies will get you the attention of banks. That applies to contracts too. To easily attract support, the proposed facility ought to be self-liquidating in both cases, meaning that the proceeds will liquidate the facility. The bank will generally lend against the proceeds and may therefore not impose a the burden of additional security.

6. Direct Credit
This facility relates to the value of cheques lodged into the customers' account. The cheque clearing system means that you don't get immediate value on cheques you pay into your account, drawn on other banks. You receive value at the end of the clearing process when the paying bank has given value. With upcountry cheques, the waiting period is longer. Whether cheques are local or upcountry, the fact is that the beneficiary would rather have value right now. For some businesses, the volume or timing is so significant that they formally seek direct credit arrangement with the bank. By this, the bank gives credit on their cheques, which they can immediately draw on, once the cheques are lodged. The implication is that the bank funds you for the value of these cheques, while it goes through the process of clearing them.

Banks will take steps to protect themselves against the possibility of dishonour of such cheques. For instance, they may allow only a proportional utilisation, say 70% of the value. They will also bother about the reputation of the customer. The reputation of the issuer(s) will also influence the bank's decision. The bank will decide, in the end, how best to secure any exposure that might arise. The point to note is that this is a possible window for cushioning your working capital requirement. If you need it, try you banker to see if you qualify.

Continue To:
Short-term Funding Options To Drive Your Business (Part 11)

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