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Bridging the Cash Flow Gap: The Role of Secured Facility Financing
Engage with this piece because even the most profitable Canadian firms face cash flow challenges – and there's a solution.
The Ironic Reality of Profitable Businesses
In the complex landscape of Canadian business finance, there's an often misunderstood irony: even more established businesses can be profitable on paper and still face liquidity challenges.
This article delves deep into the intricacies of business cash flow, highlighting the pivotal role of secured lines of credit. For Canadian businesses, from bustling FP 100 companies to nascent startups, understanding the distinction between profit and available cash is crucial
. As we navigate the world of operating loans, inventory margining, and the nuances of bank-secured credit lines, we'll uncover the tools and strategies that ensure sustainability amidst booming growth. Whether you're a seasoned entrepreneur or new to the world of business finance, this guide provides invaluable insights to help secure your company's financial future.
The Importance of Operating Loans
It's actually pretty simple when you think of it but because your firm has made that investment in accounts receivable, inventories, and other working capital assets you need operating loans to make your business work - on a day to day basis.
Running Out of Working Capital
It's pretty safe to say that if you are running out of cash or working capital, whether you're an FP 100 company in Canada, or all the way back to a start-up is a concern for any business person. And of course, the business papers are full of those stories every day.
Bank Secured Lines of Credit
So that’s put us squarely in front of the bank with the proverbial tin cup in hand! Yes, there are numerous alternative sources of cash flow and working capital, but our focus here is on small business line of credit and bank secured lines of credit. Oh, by the way, there aren't really business banking unsecured line of credit solutions for your business, so we're in a narrow field here!
Canadian Chartered Banks and Lines of Credit
Canadian chartered banks do it a bit differently when it comes to operating lines and lines of credit with a defined credit limit.They take an assignment of your assets (just in case!) and wrap this security agreement into a demand loan type arrangement. These are typically reviewed on an annual basis.
Understanding the Value of Your Secured Facility
How much you 'get' from your secured facility is, in general, pretty standard. Typically that’s 75% of what is called your 'eligible' receivables, which are those clients of yours under 90 days and within North America. On occasion clients that have extensive foreign receivables are required to compliment business lines of credit with export credit insurance from government organizations such as EDC and some other private firms.
Inventory Margining
Inventory margining under business lines of credit is a bit trickier. It is rare you can achieve 50% borrowing value, and all sorts of analysis might be required on the type of inventory you wish to finance.
The Risk in Inventory Financing
Giving due credit to the banks, it's safe to say that any type of inventory financing for capital purposes is risky, and any lender rarely gets back what they have loaned out on this asset class.
Secured Capital Facility: Discretion and Privacy
One of the areas that work well under a secured capital facility is that your borrowing is your own business. There are no client notifications, and your customers would really only be notified in the event of a default by your firm. In this case, your customers would be asked to pay the bank directly, which only makes sense.
The Potential Danger of Misusing Business Lines of Credit
If there is one danger area in a business line of credit it is simply the fact that your business should use these funds for short term working capital. Taking these funds you have borrowed on a short-term basis to buy equipment or make longer-term corporate investments generally leads to problems.
Key Takeaways
The Ironic Relationship Between Profit and Cash Flow:
Even if a business is profitable, it doesn't mean it has the necessary cash flow. A company can experience strong growth and profitability but still face financial difficulties due to a lack of liquid assets or cash at hand
Importance of Operating Loans:
For a business to function smoothly day-to-day, it needs operating loans. This is especially true if a firm has significant investments in accounts receivable and inventory, as these assets might not be readily convertible to cash.
Bank Secured Lines of Credit:
These are essential financial tools that offer businesses access to cash, based on the value of their assets. They are more commonly available and reliable than unsecured lines of credit.
Value of Secured Facility:
How much a business can borrow is typically based on the value of 'eligible' receivables (like invoices less than 90 days old from North American clients). Businesses often can borrow up to 75% of these eligible receivables. Some businesses with extensive foreign receivables may need additional measures like export credit insurance.
The Proper Use of Business Lines of Credit:
It's crucial for businesses to use these funds primarily for short-term working capital. Misusing these funds, such as for long-term investments or equipment purchases, can lead to significant financial challenges. Requirements and repayment terms can differ among lending institutions, asset based lenders, and online lenders.
Conclusion
If you're uncomfortable with banking terminology, which banks offer what business services, or want to learn about any potential downside in business banking consider speaking to 7 Park Avenue Financial, a trusted, credible and experienced Canadian business financing advisor. We'll focus on providing business lines of credit secured facility capital for your business loan needs with real-world business advice.
FAQ
What is the primary benefit of secured facility financing for businesses?
Secured facility financing from a lending institution provides a valuable tool and essential capital that businesses need to sustain their growth and profitability, ensuring smooth day-to-day operations of the business bank account despite investment in accounts receivable and inventories. Seasonal businesses can significantly benefit from lines of credit.
Why should a business opt for bank secured lines of credit instead of unsecured ones?
Unsecured lines of revolving credit for businesses are rare in the banking world. Secured lines of credit, backed by assets, offer more reliability and are more commonly available for businesses of all sizes.
How do Canadian chartered banks differ in their approach to secured lines of credit?
Canadian chartered banks typically take an assignment of an SME / small business's assets as security and incorporate this into a demand loan arrangement with a defined credit limit, reviewed annually. Banks also place a reliance on the personal guarantee of owners and owner credit history. No minimum monthly payments are required as long as the secured facility fluctuates properly. The interest rate on bank financing is the most competitive in Canadian business.
What is meant by 'eligible' receivables?
'Eligible' receivables for a small business loan/line of credit usually refer to the clients of a business who owe money for invoices that are less than 90 days old and are based within North America with generally good credit history/ credit rating of the businesses's customers.
What are the risks associated with inventory financing?
Inventory financing for the business owner is considered riskier in business loans for SME's/ small businesses as lenders rarely recover the full amount they've loaned out on this asset class.
What is the difference between a business line of credit and a term loan?
A business line of credit approval offers flexibility, allowing businesses to draw funds up to a set limit as needed and pay interest only on the amount drawn. A term loan provides a lump sum upfront, which is repaid over a fixed term with interest.
How does one determine the creditworthiness of a secured line of credit?
Creditworthiness is determined by several factors including business financials, good credit score, history of repayments, and the value of business assets provided as collateral.
Are there any fees associated with setting up a secured line of credit?
Yes, banks and some asset based lenders often charge setup fees in addition to the interest rates on the facility for a small business line of credit requirements, or annual fees for maintaining a secured line of credit. The exact amount can vary based on the lender and the size of the credit line. Interest begins to be due on a facility when drawdowns commence on borrowed funds on available credit.
What happens if a business defaults on its secured line of credit?
In the event of a default of loan repayment terms, the bank or lender can seize the assets provided as collateral to recover the owed amount if the facility is not in good standing. This can include accounts receivable, inventory, and other specified assets.
