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The Financial Conduct Authority (FCA) announced on 11 January 2024 that a review will be conducted

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The ultimate guide to commercial finance

26th January 2022

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Commercial finance has changed a great deal over the past decade, with traditional banks no longer being the only option available to businesses. Traditional lenders have been joined by alternative lending providers who can offer specialist and often creative solutions to a business’ lending options.

In our guide to commercial finance, we take a look at some of the commercial finance solutions available to businesses, and how your businesses could benefit from them.

Commercial lending

What is a commercial loan?

A commercial loan is a debt-based funding arrangement between a business and a financial institution. Businesses usually make use of commercial loans to fund major capital expenditures, cover operational costs, or pay off existing debt.

Applying for a business loan

As with a private loan, business loans are subject to the “creditworthiness of an applicant”.  This means a business must prove its long-term viability to repay the loan. When you apply for a loan with a broker or lender, it is likely that they will require you to provide certain documentation to support your application. This can include business accounts and a copy of the business plan. This is to prove that your company has a favourable and consistent cash flow.

Advantages of a commercial loan:

  • Access to capital

A commercial loan provides quick additional cash for a business. The cash may be used to purchase new equipment, satisfy payroll expenses, and generally help the business achieve its commercial or operational goals.

  • Easy application process

Applying for a commercial loan may seem daunting, but it’s much easier than people think, especially if they make use of commercial brokers.

  • Retaining ownership

A commercial loan does not dilute the business owner’s equity. For example, some businesses issue equity to raise money when required. In doing this, the owner dilutes their own equity in the business.

Disadvantages of a commercial loan:

  • Interest

As with all loans, commercial loans have interest rates. These rates can be either fixed or variable and will increase the amount of money required to pay back on top of the loan figure.

  • Risk of default

No business is completely risk-free, and as we have learned with the recent pandemic, even the most steadfast businesses can be taken by surprise by external factors. Defaulting on your loan (or even making late payments) may negatively impact your business credit score. In some cases, it could also impact your personal credit score. If you have taken a business loan and are struggling to make repayments, contact your lender or broker to discuss your available options.

What can a business loan be used for?

A business/commercial loan can be used for many different reasons within a business, these include:

  • Boosting your cash flow
  • Paying business expenses such as VAT bills or Insurance premiums
  • Help with payroll
  • Manage uncertainty
  • Grow your business
  • Cover revenue gaps
  • Purchase new services or equipment
  • Fund new product or service development

Invoice finance

What is invoice finance?

Invoice financing is when a lender uses an unpaid invoice as security for funding. It is possible to access up to 90% of the value of your unpaid invoices (with the option to protect against bad debt). The process is usually quick with the funder sometimes available within 24 hours.

The amount of money a provider will lend can vary, and each funder will have its own criteria.

Types of Invoice Finance

There are two types of invoice financing available:

  • Factoring
  • Invoice Discounting

This allows businesses to generate money against unpaid invoices. The funder will lend you up to 90% of the value of your invoices. It will manage your sales book and collect payment for your invoices directly from your customers. Once the payments have been received, the funder will deduct the costs of the factoring service, then pay you the remaining balance.

Invoice Discounting

This option is very similar to Factoring, but your business retains control of customer payments. You pay a fee and a discount charge (like interest) if you use this form of funding.

Example of how Invoice finance works

A UK manufacturing firm, with outstanding invoices worth £5000 due in 45 days, needs quick money to fund new product development.

The business goes to its friendly finance broker to discuss the possibility of invoice financing. After chatting through their requirements and showing their receivables invoices. The finance broker (along with a finance lender) agrees to fund 85% of the outstanding invoices (£4,250), with the customer agreeing to pay a fee of 3% (£150).

When the business’ customer pays the original invoice, the business gets the remaining value of the invoice (£750) minus fees (£150), equaling  £600.

Advantages of Invoice Finance

  • Improve your cash flow – Invoice financing speeds up your business’s access to the money that it’s owed from its debtors, meaning you have a steady flow of cash even if your debtors do not pay on time.
  • Flexible in terms of how you can spend the facility – Unlike business loans, you will not usually need to justify or explain what the funds are to be used for.
  • Retain Ownership – As with business loans, invoice finance allows business owners to retain all the equity of their business.

Disadvantages of Invoice Finance

  • Decreases profits – It is possible that the interest and processing charges that accompany invoice finance can lead to reduced profits on invoices that have been financed. However, the prospect of growth and early access to cash usually offset this disadvantage.

FX transactions

What are FX transactions?

Foreign Exchange (forex or FX) is the trading of one currency for another. For example, one can swap the British pound for the euro, or the US Dollar. Foreign exchange transactions take place on the foreign exchange market, also known as the forex market.

The market is open 24 hours a day, five days a week across the major financial centres around the world. This means that you can buy or sell currencies at any time during the day.

How FX Transactions can affect businesses

If you run a business that sells products or services to a country outside of the United Kingdom, then a change in the exchange rate will directly impact your bottom line. If your invoices are submitted to customers in the foreign currency, there is a risk that you will receive less money than expected if the exchange rate moves against you between the time the invoice is issued and the date of payment.

Additionally, if your business buys goods or contracts with a supplier from a foreign country, you become vulnerable to fluctuations in the exchange rate. If the value of the pound drops, you could end up paying more than you expected to for your goods and services.

What are the options for negating the risk of FX transactions?

To negate risk from currency fluctuations, it is important to make use of hedging strategies that can protect foreign investment from currency risk when the funds are converted back into your home currency.

A forward contract is an agreement between two parties to buy or sell a currency at a present exchange rate and a predetermined future date. This option provides a fixed rate and allows for accurate forecasting of potential payments and profits.

Property Finance

If you are looking to grow your business and need to buy a new property or extend your existing premises, then commercial property finance could help.

There are two types of commercial mortgage, either Fixed Rate or Variable Rate.

Fixed rates are set for a period of time before either reverting to the variable rate or re-negotiated. This could be anything from two years to the end of the loan itself. They tend to be slightly higher than variable rates.

Variable-rate mortgages adjust to changes in the Bank of England base rate.

As with homeowner mortgages, you will be required to pay a deposit on the commercial property you want to buy. The deposit amount for a commercial mortgage is usually between 25% and 40% and will depend on several factors, including the level of risk your business poses, the loan to value ratio (LTV), our credit history, and the strength of your business plan (this will vary from lender to lender).

Benefits of a commercial mortgage:

  • The interest on your commercial mortgage is tax-deductible
  • If your property increases in value, your capital could also increase
  • You may be able to rent out the property to generate extra income

Refinancing of commercial mortgages is also available, again as with homeowner mortgages, if you find a better deal elsewhere, you have the option to refinance your agreement to better suit your requirements.

Cash flow funding

Cash flow financing is a form of commercial finance in which a loan made to a company is backed by a company’s expected cash flows. Essentially this is a way to borrow from a portion of your future cash flows. Funders will create a payment schedule based on your company’s projected future and historical cash flows.

There are two areas on which cash flow projections are based: a company’s receivables and payables.

Accounts receivables are payments owed from customers for goods or services sold, and accounts payables are short-term debt obligations, such as money owed to suppliers. The net amount of cash generated from receivables and payables can be used to forecast cash flow.

The amount of cash being generated will be used by the funder to determine the size of the loan that they can offer.

Whether your business is seasonal in nature, or you have periods with larger amounts of expense or lower-income, cashflow loans can help to balance out peaks and troughs in commercial liquidity.

R&D tax claims

Research and development (R&D) tax credits are a government incentive designed to reward UK companies for investing in innovation.

Companies who are working on projects to develop new services, products, or processes, or even enhancing existing ones could be eligible for tax relief. These could include, software development, engineering design, new construction techniques, bioenergy, cleantech, agri-food, and life and health sciences.

To benefit from tax relief, the company must:

  • Be a limited company in the UK that is subject to Corporation Tax.
  • Have carried out qualifying research and development activities.
  • Have spent money on these projects.

Find out if you’re eligible here

There are several factors that can affect your eligibility, and a finance broker will be able to help with your application and identify if your business is missing out on any potential tax credits.

Bridging Finance

A bridging loan, or bridging finance, is a type of secured loan against property, with interest charged monthly on the money borrowed until the loan is repaid. Arranged for 1-18 months a bridging loan is used to provide a fast cash injection while waiting for other funds, hence “bridging the gap”.

One of the main uses of bridging finance is purchasing property, especially at auction before funds from a commercial mortgage are available.

Interest is usually rolled into the loan and repaid at the end of term, or sooner if the loan is repaid early.

RLS or Recovery Loan Scheme.

The RLS was introduced in the summer of 2021 to help businesses following the Coronavirus pandemic. And while the scheme has ended, there may be future schemes available to businesses should another unprecedented event occur.

Designed to support businesses who had been adversely affected by the pandemic, the scheme is running until December 2021 (although there is a chance it might be extended), and is available to businesses who comply with the following eligibility:

  • Business trading in the UK
  • Be a viable business were it not for the pandemic
  • A business that has been adversely impacted by the pandemic
  • Is not in collective insolvency proceedings

How Much Can you borrow with the RLS?

Businesses can borrow £25,001 to £10 million (Term loans), for up to 3 years, and Invoice or asset finance loans of between £1,000 and £10million, over a 6-year period. The actual amount offered, and the terms are at the discretion of participating lenders.

Exemptions to the RLS

Businesses of any size can apply for RLS assistance, however, there are several sectors that are ineligible:

  • Banks, insurers, and reinsurers (but not insurance brokers)
  • Public-sector bodies
  • State-funded primary and secondary schools

There are also a number of excluded purposes that can not be used with RLS:

Hire purchase or leasing of cars or other vehicles subject to personal taxation

  • Variable-rate deals
  • Direct financing of specific export activity
  • Operating lease

What information is needed to apply?

Typically, all that is needed is historical business accounts, the reason of the funding being sought, and information on how COVID-19 has impacted the business.

This does however vary between funders, and Additional information may be required to process your application.

Why use a finance broker for commercial finance?

Even if you are “finance-savvy” there are still many reasons why you would choose to use the services of a finance broker.

Commercial finance brokers often have decades of in-house experience in placing finance deals and will understand all the factors required to support your finance applications, meaning the chances of qualifying for finance will be improved.

A good commercial finance broker will also be able to save you time (and hopefully money). A finance broker will be able to search through a large panel of funders quickly to find the best deal for your circumstances.

If you would like to discuss commercial finance solutions with a member of our team, contact us today.

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