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How Finance Makes the SME World Go Round

Updated: Dec 3, 2019

According to a survey of a thousand UK SMEs by MarketInvoice, over the last year, 26% used invoice financing as their main form of funding, 22% used asset finance and 10% used a traditional loan. Fortunately, for UK SMEs, GSM are able to arrange all of three of these forms of funding and tailor them to your business needs, with flexibility over the repayment period and schedule.

MarketInvoice was the UK’s first online marketplace, that facilitated companies with outstanding invoices to selectively sell them in order to raise working capital. A good solution for UK SME’s who have poor paying customers and large invoices.

Invoice Finance: Invoice Financing is a method for businesses to borrow money against outstanding invoices, in doing so the lender will pay the invoice on the customers behalf giving them access to working capital. In doing so, the business can use the cashflow to pay staff salaries and suppliers or reinvest in operations and growth earlier then they could if they had to wait to be paid. The business will have to pay a percentage of the invoice amount to the lender as a fee for borrowing the money.

This is a perfect solution for businesses that have long lead times or lengthy payment terms. For example, let’s say you are a lorry manufacturer, and your lead time for a lorry is 3 months. You will most likely charge your client a deposit, let’s say 10%, but the build cost of the lorry is 50% of the final sale price. So, in order to sell the lorry, you need to build the lorry, in order to build the lorry, you need funding for the build. Some companies, will have healthy enough cashflow that they can self-fund, others may not. In which case, without borrowing they can’t tap into the 50% profit proceeds from the build.

Let’s now consider another situation, again you are a lorry builder, with a 3-month lead. An international haulage company comes to you wanting to replace their entire fleet of 100 lorries. You definitely will not have the cashflow for this, and so have no means to fund the build, as such you miss out on the life changing contract. This would be where invoice finance would be a perfect solution.

After signing the contract with your client you provide a lender with the invoice, such as Market Invoice, who then advance the business the amount you require. Taking this advance, you invest in the stock you need to meet the order, and after 3 months you have 100 lorries ready to be delivered to the haulage company. On receipt of the lorries, the haulage firm pays the invoice for their lorries, which is then used to settle the debt with the lender. How the lender is paid depends on how the finance is structured mainly whether you have taken out Invoice Factoring or Invoice Discounting.

finance contract

Invoice Factoring: You sell outstanding invoices to a lender, the lender then collects the outstanding invoice from your client. As such this may highlight to your client the use of this arrangement and it may not reflect the image of how you want to be perceived.

Invoice Discounting: With discounting, you, as the business collect the payment from the customer and as such, they remain unaware of your arrangement.

Typically, businesses will be able to borrow as much as 95% with discounting but only up to 85% with factoring. Over this period, you will incur fees and interest for the service which will of course need to be paid off, however in this scenario the cost of not having invoice financing available would have been far greater.

Now let’s consider the haulage company, who want to order the 100 lorries. Perhaps this is because of new emission targets by governments or maybe it’s because there are new opportunities in the market. Regardless, they are faced with a huge investment. If each lorry costs, £100,000, then the haulage company is looking at £10 million pound investment. It is highly unlikely that they will have this amount lying around as such will have to find external funding.

One option would be to find an investor, but in exchange the business owners have to be willing to give away a chunk of their business, which they have spent their lives building. They may even endanger their control over the business. This could be a great option if the owner is looking to retire and secure a regular flow of income without having to be so involved within the business. However, if the owner has a succession plan and wishes the company to be passed down to their daughter or son, and then onto their daughter or son, external investors won’t suit their plan for significant generational wealth.

The other alternative is debt finance, which according to MarketInvoice accounts for 58% of funding for UK SMEs. Now in this scenario, Invoice Finance isn’t going to be an option for the haulage company, lorries are assets that pay themselves off over the long run, so the return will be seen over 10 or so years unlike an invoice which is an asset that will show a return within months.

So this leaves our haulage company owner with two options, a business loan or asset finance. A business loan is an option, however the amount that they are looking for is a significant amount, and in comparison to the business’s income it will increase their risk profile and as such be reflected in a higher interest rate charged. But still on option.

For this particular scenario the best option however would be a form of asset finance, either hire purchase or lease. To understand why asset finance in this situation would be best, we first have to look at it from a lenders point of view. The asset that they are lending against has a reasonable residual value, in other words, at the end of the lease agreement a large proportion of value remains within the asset. Lenders also have the added security that if the business for whatever reason can’t meet its repayment schedule, they have first charge on the asset, so they simply can take the asset from the business, sell the asset and recoup their loan.

Whereas with a business loan, the lenders have little recourse, you may have spent the loan on raw materials, you may have used it to pay off outstanding debt, or on staff salaries. There is little the lender can do to recoup the loan, as such to cover this increased risk they charge a higher interest rate.

Apart from potentially lower interest rates, with a hire purchase agreement, the lender is responsible for servicing and maintenance. The draw back however with a hire purchase agreement is that the full amount of VAT is due upfront, which for a £10 million-pound order is £2 million. If the business has this in the bank then this would be a good option. Repayments for the fleet of new lorries can then be spread over two and five years, and paid monthly, quarterly or yearly depending on the preference of the business owner.

If the business isn’t able to pay the VAT upfront, the other option is leasing, where the cost of the VAT is rolled into the repayment schedule. The drawback is however that you are then responsible for the maintenance and servicing. Alternatively, for the business owner, they could use a combination of a business loan and a hire purchase agreement. If their preference is to use hire purchase, to benefit from the service and maintenance aspect, then they can use their business loan facilities to fund the upfront VAT.

The other alternative is opting for a VAT deferral, since a VAT registered business will be able to fully recover any VAT outlay, this can release the pressure on cash flow too. A VAT deferral is usually a three-month loan, the usual length of time it takes for HMRC to refund VAT claims. Upon the refund, the business simply repays the lender and any fees and interest.

The other additional benefit of leaving business loan lines available is to cover unforeseen circumstances. Regardless of how well or badly your business is doing, if you have taken out finance, you will be required to pay the repayment each month or quarter. For example, it may take our haulage business owner six months to establish himself within the new market, the reason he has invested in 100 new vehicles. So during these months a business loan may help meet the repayment schedule. A business loan should also be left free for those unforeseen scenarios, such as dips in the market or the loss of a large contract, it just gives the business greater flexibility.

As we can see from this business scenario, without the facilities of debt finance the UK SME economy doesn’t rotate. At GSM we have been proudly supporting UK SMEs for over twenty years, establishing ourselves as London’s leading finance broker. But just because we are located in London, it hasn’t stopped us helping companies nationwide, from breweries and distilleries in Scotland, to steel manufactures in Newcastle, data centres in Birmingham and restaurants across the land. Considering debt finance accounts for 58% of UK SME funding, every business should have a finance brokers number in their back pocket. No matter whether you are considering invoice finance, asset finance or just a straight business loan, give GSM a call, and we can run through the options available to you.

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