Shop around to stay in good financial health

Look at a range of banking options to prevent your cash flow from drying up, says Roger Trapp

Looking after customers and staff are among the secrets of long-term business survival, according to a recently published survey of small and medium-sized enterprises that have been in existence for more than 30 years. Pointing out that most new businesses fail within three years of starting up and that only 100,000 (2.7 per cent) of the 3.7 million businesses that currently exist in the UK are likely to reach their 30th anniversary, the survey by the London-based market research company FDS International says that other important factors include adaptability to changing market needs, hard work and determination.

The only explicitly financial issue mentioned was good control of cash flow. However, it is well known that in tough times like the present, funds can be tight. This is especially true for businesses that are dependent upon loans and overdrafts.

Indeed, experts warn that entrepreneurs and other business owners should not rely too much on such facilities, even if interest rates remain low. Steve Janes, partner with the Home Counties commercial law firm Matthew Arnold & Baldwin, says: "Overdrafts can be called in by banks at very short notice, while loans normally have provisions that if a payment is missed then the whole loan becomes due immediately."

Latest Bank of England figures do not suggest that small firms are having any problems obtaining finance and the continuing buoyant property market means that all loans secured against buildings are likely to be secure. But there is anecdotal evidence that banks managers are becoming more "nervous" about their exposure to smaller businesses and in some cases reviewing loans.

Official figures indicate that traditional term loans and overdrafts are far more widely used than other means of finance, such as factoring and invoice discounting. At the beginning of this year term loans stood at £27.8bn, with overdrafts at £10.8bn. However, the picture appears to be changing. The Factors and Discounters Association's figures for the second quarter of this year show that more than £7.2bn of funding is being provided to UK businesses by its members. In particular, there has been substantial growth in invoice discounting, which has risen 19 per cent since June 2001.

The association says the continued growth in the factoring and invoice discounting sector is now challenging the traditional overdraft as the preferred form of funding for SME growth. The current figure for overdrafts represents a 68 per cent fall over the past decade, it adds.

Steve Janes suggests that, before borrowing to fund investment or provide working capital, business owners should explore the wide range of other financing arrangements available, since many will offer greater flexibility without giving banks a hold on the business.

Among the alternatives are factoring and invoice discounting. Both are arrangements used to raise finance by borrowing at a discount against the face value of invoices and receivable payments. The difference is that, under factoring, the lender collects from the customers, while with invoice discounting the business retains credit and control.

Both approaches have traditionally been resisted because they have attracted an image as "lending of last resort". However, recent years have seen attitudes change, partly as a result of banks and finance houses making them more sophisticated so that it is not so obvious to customers that the approach is being used.

Janes points out that they can be better for cash flow than more traditional forms of finance. For example, a bank loan is unlikely to produce more than 40 to 50 per cent of the business's turnover, while with factoring or invoice discounting the business can expect to receive 70 to 85 per cent of the value of the invoices, depending on the type of business. Other alternatives include stock financing, which is also known as inventory finance and involves an advance against the value of deliverable stock. However, further charges or guarantees are required and existing loans may prevent such arrangements.

Finally equipment leasing and hire purchase can be used to ease cash flow and effectively raise finance to help the business expand or stay afloat in the current turbulent times.

Businesses traditionally opt for loans or overdrafts because they feel safer and more in control of their destiny – even though the small print may suggest otherwise. The message advisers are seeking to convey is that any business looking for finance should look at a range of alternatives. This will be even more important if the value of commercial property – against which most loans are secured – starts to fall, as has happened in previous recessions.

Nor should they necessarily listen to their bank managers. Only 39 per cent of those in the FDS survey who had sought advice from their banks thought they had provided value for money.