Cash is the lifeblood of any business. The cash you need to keep on hand to pay regular operational expenses like payroll, utilities, marketing expenses, etc. is commonly referred to as “working capital”. Sufficient working capital is always necessary to keep your business afloat and it tends to get tighter when you have growth opportunities—you now need to spend more on hiring people and purchasing raw materials to fulfil contractual requirements for a growing client base. It is normal that payments for your products and services only come some time later, after the requirements have been completed.
Aside from saving and carefully planning their business finances, some business owners opt to take out business loans to support their growth goals. The two major financing options available to them for this purpose are bank loans and private financing. There are many types of business loans from these financing providers. But in order to help you better understand which options best suits your needs, let’s tackle the pros and cons of each:
When business owners do the math and realise they need additional funding to support their growth plans, their primary instinct is to apply for a bank loan. A bank loan is a widely-used financing option which has two distinct advantages that make it ideal for business owners.
- Low-interest rate
Compared to other sources of business funding, bank loans offer one of the lowest interest rates. Banks are able to offer lower interest rates due to rigorous qualifying standards. Banks will usually require multiple payment assurances to qualify: business and personal collateral, co-signers, and life insurance on the borrower are just a few of the requirements that banks may levy to ensure payments. The general rule is that the more certain payments are, the less risk is involved, and interest rates always vary with risk assessments.
- Fixed payments
Fixed payments are another reason business owners prefer financing loans from traditional banks. Business owners like the regular and unchanging payment schemes which are a common characteristic of bank loans because it allows them to plan their finances more accurately.
- Lengthy Application Process
Alongside these advantages are some drawbacks. The first on the list is the lengthy paperwork that banks require from the borrowers. While all credit facilities and lending firms necessitate the submission of pertinent personal and business documents, banks have a reputation for seemingly excessive paperwork.
- Slow Turnaround Time
Due to their somewhat protracted application processes, banks follow a different pace. It simply takes them longer to process loan applications, partly because they conduct meticulous credit checks. Banks will carefully review a borrower’s finances in order to gauge their financial capability to repay the loan. This includes sifting through balance sheets to check all their assets and liabilities.
- Requires Collateral
While we’re on the topic of assets, note that most bank loans require collateral. Some business owners may be open to the idea of securing their loan with collateral since this can help bring the interest rates down. However, this could be a problem for business owners who either do not have assets to pledge to the bank or are hesitant to risk their assets.
Some business owners who do not qualify for bank loans will turn to private financing firms to seek additional funding. And they are becoming more popular most especially with SMEs because of the following advantages:
- Simple and Fast Application Process
Businesses are more keen to get funding from private financing firms mainly because their application processes are easier and more streamlined compared to banks. When it comes to requirements, private financing firms utilise online portals, allowing borrowers to simply upload copies of the document requirements. Furthermore, private firms’ turnaround time for checking and validation is significantly shortened because they apply innovative technology to speed up the process.
- Financing approvals based on ability to pay
Instead of looking at your personal or business credit history, most private financing companies focus more on your ability to pay based on your cash flow projections. This enables newly-opened businesses to gain access to business funding even though they haven’t successfully established a strong credit yet. For purchase order and invoice financing, the focus shifts to the transaction itself, where the customer’s ability to pay is much more significant than the business owner’s personal finances.
- Off-balance sheet financing
A key feature of the short-term nature of private financing is that in many cases, it is viewed as a cash management strategy or “normal” business expense instead of a long-term structural debt. Using a well planned short-term financing strategy to address working capital requirements helps to preserve the health of your balance sheet, which in turn helps you qualify for bank loans in the future when they are more appropriate, like in building a new factory or launching a new product line, etc.
- High-interest rates
The downside is that private business loans typically have higher interest rates than traditional bank loans. This is to compensate for the higher perceived risk in simplified qualifying standards. The higher interest rates are somewhat mitigated by the short-term nature of the financing - the total interest paid tends to be somewhat lower due to the shorter loan terms.
- Shorter repayment terms
Most private financing companies offer short repayment terms which are not ideal for businesses who are seeking long-term financing. This is why most companies who opt to get funding from private financing companies are those who have temporary cash flow challenges.
Factors to consider before seeking funding
Knowing the pros and cons of traditional bank loans and private financing is one way of helping you arrive at a decision that works for your current business financial position. But before making your final decision, you may also want to consider these salient factors:
Purpose for Financing
You have to be clear on why you’re seeking financing or your business can face consequences. Think carefully and identify the reason why you need extra funding: Do you need it to invest in additional inventory? Is it for property acquisition? Do you need to hire more people to fulfill the client’s orders? Being clear on your financing objective will help you have a better view of how profitable the investment can be and how long it will take to see positive cash flow.
Once you have figured out your financing objective, it will be easier to determine how much you need to borrow to pursue your growth plans. This is when you need to work closely with your accountant or your business finance advisor. Do the math and draw up the numbers in order to understand exactly how much you need to borrow.
The amount you aim to borrow is relative to the type of financing option you apply for. Banks offer higher credit limits compared to private financing companies. But note that it takes time and effort to qualify for a bank loan. To increase the credit limit, some financing providers require submission of collateral. But be mindful of pledging collateral for funding. Because in case you fail to make timely payments, the financing provider will have the right to take the collateral you pledged.
Earlier, we mentioned that one of the reasons business owners prefer bank loans is because of the fixed monthly payment. However, there are some bank loan products that offer revolving credit wherein businesses pay monthly depending on the amount they borrowed (like how credit cards work). Some private financing firms may also offer a flexible payment scheme, depending on the terms you agreed on. At the end of the day, choosing between fixed or monthly payments boils down to your business cash flow status and how you plan to repay the loan.
Choose a financing option that suits your financial requirements.
So which financing option are you considering? A bank loan is a popular choice. Unfortunately, not all businesses can qualify for one. If you’re one of these businesses, you can try applying for private financing. But instead of focusing on which financing option you will qualify for, contemplate which best fits your current financial situation. You may qualify for a bank loan, but are you sure that a bank loan is what you need? In the same way that you may prefer the simple and fast application process of private financing firms, but are you capable of paying the high-interest rate that goes along with private business loans? Again, it all boils down to why you’re seeking funding and how do you plan to repay the credit.
If our growing business if facing short-term financial challenges, First Circle is one of the innovative private financing firms you can turn to. First Circle ardently supports the growth goals of local SMEs by offering business financing opportunities in the form of Purchase Order Financing and Invoice Financing. Click here to apply.