100 business financing uk - Business Financing UK(1)Nature of Business Finance: Financing a business

Navigating the world of business financing in the UK can be complex, whether you're a startup or an established enterprise. Understanding the various types of funding, how interest rates are determined, and the role of security is crucial for securing the capital your business needs. This guide breaks down the essential aspects of business finance, from initial credit assessment to what happens in the event of a default.

What is Business Finance?

Business finance involves securing funds for various operational needs. This can include financing the acquisition or holding of assets, which fall into two main categories:

• Fixed or Long-Term Assets: These are typically larger, more permanent investments such as machinery, equipment, or buildings.
• Short-Term, Current, or Working Capital Assets: These cover day-to-day operational needs like managing stock, receivables (money owed to your business), and expenses incurred during an operational cycle. An operational cycle is the period it takes for a business to recover its costs, expenses, and charges through the sale of goods or services.

How Do Interest Rates Work for Business Loans?

Interest rates for business financing vary depending on the loan type and market conditions. For fixed or long-term assets, financing often comes as a term loan, repayable over a medium term (e.g., three years) or a long term (e.g., five, seven, or ten years).

The interest rate can be either fixed or variable. Variable rates typically align with current market benchmarks, such as the inter-bank offer rate (or its equivalent), which is the rate at which banks lend funds to each other. Both fixed and variable rates are usually a few percentage points above these benchmarks. Short-term financing, often in the form of an overdraft or cash credit, also carries an interest rate a few percentage points above the benchmark, sometimes higher than long-term loan rates. This is because the outstanding asset cannot always be matched against a specific liability, leading to additional planning and arrangement costs for the bank.

What Are the Preconditions for Business Loan Approval?

A critical factor for any business finance approval is the borrower's credit standing or rating. Lenders assess your creditworthiness by reviewing your past track record of honoring financial commitments without defaulting. This includes:

• Credit card dues
• Previous loans
• Other financial obligations

If your credit rating is not sufficiently high, the interest rate charged on the loan or credit facility will likely be significantly higher than for businesses with a strong credit rating.

What is a Trust Receipt Facility?

A Trust Receipt (T.R.) facility allows a bank to extend credit to a borrower for payment to a supplier. This is based on a trust receipt signed by the borrower upon receiving the bill of lading, airway bill, air consignment note (covering goods dispatch), or simply a delivery receipt. This facility is generally considered a clean or unsecured facility and is typically stipulated to be paid or adjusted within three months.

How Do Letters of Credit (L/C) and Bank Guarantees Support Businesses?

Letters of Credit (L/C) and Bank Guarantees are crucial tools for facilitating trade and contract work:

Letters of Credit (L/C)

Some businesses need to establish an L/C in favor of their supplier to procure stock. This ensures the supplier receives prompt payment from the L/C-opening bank upon dispatch of goods and submission of conforming documents. By opening an L/C, the bank enables the business to operate effectively, securing necessary supplies. In other cases, a supplier might extend credit supplies to a business, provided a bank assures payment upon the expiry of the credit term under an L/C.

Bank Guarantees

Businesses undertaking contract work often need to furnish tender money, security deposits, or earnest money deposits to their clients (principals). They may also face deductions of a certain percentage before receiving progress payments. These requirements can tie up a business's funds. Bank Guarantees, provided in lieu of these deposits or deductions, allow a business to successfully carry out contract work with limited funds and without heavy borrowing.

Furthermore, principals (such as government departments) may provide funds to commence contract work in the form of mobilization advances. These advances are typically contingent on the business furnishing Bank Guarantees to ensure the due execution of contracts and the eventual adjustment of these advances against progress payment bills.

What Security is Required for Business Financing?

Business financing is usually supported by a charge over the financed asset, whether it's a fixed asset or a short-term/working capital asset. The type of charge depends on the asset:

• Mortgage: For fixed assets like land, buildings, or machinery embedded in the ground or a building, the charge is typically in the form of a mortgage.
• Pledge or Hypothecation: For working capital or movable assets like stocks, the charge is a pledge or hypothecation. Hypothecation involves creating an interest over the assets and granting the bank the power to take possession of and sell or realize their value. If the asset is in the form of receivables, the charge is also hypothecation, combined with the power to collect or recover those receivables.

How Do Lenders Supervise Loans and Security?

A bank that has lent against security makes it a rule to regularly monitor the security to ensure it remains intact and of sufficient value. This involves:

• Site Visits: Lenders regularly visit the place of business to confirm that the assets exist as financed or as reported in the borrower's periodic statements, as per the lender's stipulations.
• Invoice Verification: They randomly verify purchase and sales invoices, especially for major transactions, to ensure the values of stocks and receivables are adequate to cover the outstanding debt, accounting for the margin to be maintained by the borrower.
• Asset Assessment: Lenders verify that stocks are marketable, not too old or obsolete, and that receivables hypothecated to the bank are genuine, correct, and realizable.

What Happens in Case of Default?

When a borrower defaults on repayment installments or interest, lenders take action to recover the outstanding dues:

• English Mortgage: With an English mortgage, the asset (e.g., land or building) can be taken possession of and auctioned or sold without resorting to court action.
• Hypothecated Assets: For hypothecated assets (e.g., stocks