02 Oct Say goodbye to your business overdraft with a revolving credit facility
Changes in the availability of some traditional sources of finance, and structural limitations with others has changed the borrowing landscape. It has meant that UK businesses are looking elsewhere for their working capital needs. A revolving credit facility which pays your suppliers can provide a flexible and cost-effective option for a growing business. It provides access to cash flow at an earlier point in the working capital cycle, and can be used either as an alternative to a business overdraft, or work alongside it as a complementary solution.
The importance of working capital
Working capital is fundamental to the survival and growth of a business. It’s essentially the amount of money a business needs to stay in operation. Any business without an adequate amount of working capital will be unable to pay for short-term liabilities and financial obligations.
Maintaining healthy working capital within the business has many advantages:
Prompt and regular payment ensures robust and fruitful supplier relationships.
A robust supply chain means uninterrupted order fulfilment, improving the reputation of the business.
Having good working capital and a strong credit rating allows a business to secure credit with favourable terms.
Adequate working capital ensures that a business is prepared for any potential downturn or crisis.
A strong working capital position allows a business to take advantage of expansion opportunities as they arise.
If you are a public company, healthy working capital helps to maintain a healthy share price.
Working capital is also fundamental to the growth of a business. It pays for new branches, more staff, product development, and market research. Good working capital management is essentially a balance between growth, profitability and liquidity.
A changing landscape
There are now many options available for businesses to augment their working capital to fund growth or ride the peaks and troughs of demand. From the traditional business overdraft, secured loans, or invoice finance, they all provide working capital in different ways.
The most well known of these options is the business overdraft. However, the financial landscape is changing. Many businesses are finding it difficult to secure an overdraft, and/or are discovering more suitable options are available.
Goodbye to the business overdraft?
A business overdraft provides a temporary source of funds outside of usual cash flow. It provides instant access to borrowing once a business’ account balance drops below zero, and brings cash into the working capital cycle to cover immediate costs. Typically overdrafts are arranged in advance, have a set borrowing limit and are agreed over a period of 12 months.
However recent evidence suggests that this useful and flexible option has become increasingly difficult for growing businesses to secure.
The Forum of Private Business (FPB), the national business group, has reported a decline in overdraft usage in recent years. The proportion of business using an overdraft has dropped from 25% in 2011 to around 17% in 2015, according to its figures. While according to research conducted by Funding Options, overdrafts are being withdrawn from UK businesses at a rate of over £5m per day.
Growing businesses unable to secure funding through this traditional route can be faced with a number of problems. They can be:
1) The risk that expansion outpaces available funding, creating a cash flow shortage.
2) The risk that normal peaks and troughs in the cash flow experienced by most businesses cannot be accommodated.
So why are we seeing a reduction in business overdraft lending?
The Bank perspective
The general reduction in bank lending since 2009 is a result of a number of factors:
Firstly, a business overdraft is unstructured in that there are no fixed repayment terms. Therefore the debt sometimes is unlikely to be repaid, and this can cause problems for a Bank’s business model.
Secondly, ABN AMRO found that since 2008, 92% of UK businesses have breached their overdraft limit. And they have done so twice a year or more on average. Also, businesses admit to having spent an average of 20% of the past year in excess of their overdraft limit.
Linked to this, is also a lack of visibility about what is being funded through the overdraft. Rather than funding working capital it could being used to fund fixed assets or even hide losses. So for the banks, potential financial issues in a business are being hidden.
Lastly, the Bank needs to earn an economic return from lending on a business overdraft. However, if an available overdraft facility is not used, the Bank does not make the required return.
Banks are therefore increasingly reluctant to extend large overdrafts to UK businesses. They now prefer customers to use more structured products like invoice discounting. A revolving credit facility to pay suppliers is also becoming a popular recommendation that business banks make to their customers. The Pay4 partnership with Santander is just one instance where banks are now recommending this kind of facility to their business banking customers.
Assessing the overdraft from the business view point
Overdrafts have historically been a useful tool for businesses that need to access additional funds. Businesses are generally free to use them how and when they want to. They are extremely useful to cover peak cash flow requirements.
However, they also require security, and this makes them unattractive or unsuitable to some business owners. For instance, businesses without the assets available to support guarantees will not usually be offered this facility. A company also runs the risk of those assets being called upon if it fails to repay the overdraft when asked.
Overdrafts also come with ongoing fees attached, which means that the Business has to pay for the credit even if it doesn’t use the facility. There are arrangement fees that are often levied when setting up the facility, as well as renewal fees typically charged on an annual basis. These fees are in addition to the interest charged on the overdraft itself.
So whilst the business overdraft has some benefits for the business, it also has some disadvantages for Businesses who have them.
Introducing a complementary revolving credit facility
For a sustainable working capital strategy, business overdrafts work better in conjunction with more sophisticated forms of finance. A revolving credit facility to pay suppliers is one of this products. It provides a consistent and pre-approved source of cash flow for a business.
Once the facility is approved, the business doesn’t have to use the entirety of the credited amount at once; it can dip in and out to re-use the facility as it sees fit. And most importantly, there are no setup fees, no non-usage fees, and no annual renewal fees.
Rather than being a ‘last resort’ for when cash runs out, a revolving credit facility works at an earlier point in the working capital cycle, allowing businesses to fund their growth opportunities as they arise.
With a revolving credit facility you still have the benefits of a business overdraft, in that it can be used when you want to cover peak cash requirements. The difference is that it is more structured, and more visible. Rather than having an open-ended repayment schedule, businesses know precisely what the repayment will be and when. This makes cash flow management more predictable and more robust.
Flexible funding for growth and stability
With the decline in overdraft lending set to continue, more businesses are turning to alternative forms of business finance. A business overdraft can be seen as the default traditional option to support short term working capital requirements. They may be useful for managing short term cash flow gaps, but there are distinct downsides from both the Business and Bank perspective.
Businesses are therefore also recommended to look to a range of more structured, cost-effective and flexible alternatives. A Revolving Credit Facility to pay suppliers is just one alternative that provides a more robust working capital solution. Because cash is being introduced earlier into the working capital cycle, businesses are able to focus their finances on growth, rather than merely keeping their heads above water.
Revolving credit facilities to pay suppliers allow businesses to maintain their supplier relationships, reduce exposure to the risk of running out of cash, whilst at the same time maintaining an ongoing, healthy relationship with their Bank.