When business growth or unforeseen expenses cannot be met using internal sources of financing, such as retained profit, organizations must rely on finding funds from lenders or investors.

How it works

External financial support comes in various forms, including bank loans and issuing shares. The available sources of outside financing depend on the amount a company requires, and whether the money is needed to resolve a short-term issue, such as cash flow, or for the long-term growth of the business. While short-term financing is easier to secure, finding larger sums for an expansion is more challenging. A company that is either already listed on a stock exchange or is preparing to enlist will be able to raise the capital through the sale of shares. However, an unlisted company may struggle to raise a comparable amount. A company with a large amount of debt will also find it hard to raise funds, since lenders or investors will see the business as risky.

Raising external financing

Generating funds from external sources can be a challenge, especially when securing investors. However, revenue does not necessarily need to take the form of a loan. There are a number of strategies that can be implemented through working with external parties in order to provide a company with good working capital.

Short-term financing

A range of financial agreements that help provide a company with immediate funds can be made with outside parties as a way of raising cash short-term.

Bank line of credit Borrow from business checking account up to an agreed limit, with interest typically at a high rate.

Debt factoring Sell unpaid invoices to an external source for an agreed amount in order to receive immediate payment minus a commission fee.

Invoice discounting Borrow money against sales invoices customers are yet to pay (again, often at a disadvantageous rate).

Long-term financing

Putting effective measures in place to provide ongoing revenue is essential for a company’s long-term growth.

Shares Raise capital by issuing shares to finance growth. The company then retains less
profit, as it pays dividends to shareholders, who also benefit from any capital gains in the company’s value

Borrowing Secure long-term loans from banks and other financial institutions, usually on better terms than a bank line of credit.

Finance leases Sell expensive assets such as computers to finance companies to release capital, and then lease them back.

Rent-to-own agreements Pay for expensive assets, such as vehicles, in installments. Overall cost may be higher, but capital is not tied up.

DEBT FACTORING PROCESS

To get money immediately, a company sells unpaid invoices (accounts receivable) to a third party, known as a “factor.” The factor advances the company a major portion of the amount, retains the rest until the account is paid, then charges a fee.

• Company negotiates an agreement in which its unpaid receivables (invoices) are sold at a discount to a “factor.”
• Company sends invoices out to customers, and copies these to the factor. Customer now owes payment to factor.
• Factor pays company an agreed percentage of the invoices (typically 80–90 percent) within a few days of receipt.
• Customer pays factor the invoice amount after 30 days (or more if terms of payment are longer).
• Factor pays remaining invoice amount to company, minus a fee (usually 2–5 percent of the invoice amount).

NEED TO KNOW

❯ Term loan A bank debt repaid over a set period of time

❯ Loan note A form promising payment to the holder at an agreed future date

❯ Eurobond A bond issued in a currency other than the currency of the country in which it is issued

80%
of external corporate financing is provided by domestic banks