Lending Products (4) Flashcards
What must a customer demonstrate to a bank in order to get an overdraft?
- Why the overdraft is needed
- How long they will need it for
- Their ability to at least stay within the limits
- Their ability to service the debt
What are the 5 main features of an overdraft?
1 - Interest is only charged on the drawn amount
2 - Repayable on demand
3 - The bank will charge an arrangement fee
4 - The facility is reviewed annually
5 - Depending on the size of the overdraft, the bank may take security
What are the two main types of sales (receivables) financing?
1 - Factoring
2 - Invoice discounting
What is the main difference between factoring and invoice discounting?
In invoice discounting the business retains full control of the debtor book, whereas in factoring, the debtor book would be passed over to the factor.
Imagine a business is using invoice discounting - when the customer pays their debt, who the money will go to?
The business.
Assuming there is no default, the business will receive 100% of the debt amount, they will then repay what they owe to the invoice discounter + fees.
Imagine a business is using factoring - when the customer pays their debt, who the money will go to?
The factor
The customer will pay direct to the factor. The factor will then take what they owed by the business + their fees.
The factor will then pass on any remaining cash to the business.
Assuming you are using a recourse sales financing facility, who bears the risk?
The business,
The factor or the invoice discounter will come after the business for that they are owed
Key advantages of invoice discounting/factoring?
- Ideal way to fund rapid growth by improving cash flow
- Committed facility (i.e no repayable on demand)
- The facility is higher than a bank debenture, which allows the business to mobiles their balance sheet assets.
- They help to smooth cash flows
- Useful credit info about the business can be obtained
- A non recourse facility will protect you from a default scenario
Key disadvantages of invoice discounting/factoring?
- The fees can reduce profit margins
- It will reduce your ability to take out a loan as the debtor book cannot be used as security
- Facility providers will want to vet customers to ensure they will pay before they provide the facility
- If you use factoring, the customers will realise they are paying a factor and not the business. They may judge the business for using a factor
- Not suitable for some sectors such as construction where staged payments are available anyway
Loan durations are described as short, medium and long term.
Short term is ____?
Medium term is_____?
Long term is______?
Short term is < 1 year
Medium term is 1 - 7 years
Long term is + 7 years
What are the two types of loan covenants? Give examples of each
1 - Financial - Leverage ratio must stay below 3x
2 - Non financial - The company must provide the lender will annual business updates
How do credit card providers make money?
1 - Charging fees for late payments
2 - Charging shops transactions fees
What is the difference between a credit card and a charge card?
Charge cards must be paid off each month, credit cards do not
What are the benefits of a charge card?
- Unlikely to let the user slip into debt problems because they must be paid off each month
- Easy to budget
- Charge cards come with spending rewards
Disadvantages of a charge card?
- They don’t provide revolving credit like a credit card
- If you do’t repay the debt on time, you incur late payment fee and risk your credit standing deteriorating
- High annual fees
You can purchase assets either outright or via hire purchase/leasing.
What are the advantages of buying an asset outright?
- The asset cannot be repossessed, unless its used as security for a loan
- The business is treated as the owner of the asset for tax purposes and is able to claim capital allowance
- The business isn’t tied to any repayment arrangement
- Buying outright is cheaper than hire purchase and leasing
Disadvantages of buying an asset outright?
- Paying the full amount upfront can hurt your cash flow
- You may end up buying equipment you don’t need in the future
- The cost of the asset cannot be spread to coincide with money coming into the business
- The business is responsible for maintenance of the asset
- The asset value may depreciate over time and be worth less than its purchase value
- The business takes on the risk of the asset breaking down
What is the difference between hire purchase and leasing?
In hire purchase you end up owning the asset, whereas in leasing you don’t necessarily.
The assets that can be bought under hire purchase include:
- Vehicles
- Computers
- Industrial machinery
- equipment
- furniture
The assets that can be bought under leasing include:
- Telephone systems
- office computers
- company cars
- forklift trucks
What are the three different types of lease arrangement?
1 - Financing leasing
2 - Operating leasing
3 - Contact hire
Describe a Finance lease agreement
- Normally taken out of the working life of the asset (3+ years)
- At the end of this period the business can sell or scrap the asset
- The leasee is responsible for asset maintenance
- The leaser will recover full initial cost of the asset + leasing fees over the course of its life
- The item must be shown on the SOFP as a capital item, or as an item that has been bought
Describe an Operating Leases agreement
- Taken out if the item is not needed for its entire working life
- The leaser is responsible for asset maintenance
- The business does not need to capitalise these assets on their balance sheet
Describe a Contract hire agreement
- Often used for company vehicles
- Leasing company is responsible for asset management and maintenance
- The business does not have to capitalise the asset on its SOFP
How does a letter of credit work?
The importing bank will guarantee the exporter is paid for their goods, given the importer provides the necessary paperwork, e.g. proof of postage
How does documentary collection work?
Imagine the asset has been shipped to the buyer, the importer can only claim ownership once the exporters bank releases the relevant documents (they accept the bill of exchange).
If the bill of exchange is not accepted, the exporter still has ownership of the goods, even though they are overseas
How does open account trade work?
The seller ships the goods, and then states when they expect to be paid (e.g 5 working days)
The buying receives this invoice and must pay within 5 working days
This method should only be used once there is an established trading relationship between the buyer and seller
How does bill discounting work?
The bank would give you an advance on your export sales (e.g invoice discounting / factoring)
The stronger your credit worthiness, the more you can get given upfront by the bank
What is forfeiting?
A form of bill discounting but there is no recourse to the exporter if the importer doesn’t pay
What is a guarantee / avalisation?
It’s similar to a bill of exchange (advance of export sales)
However, with the guarantee, the bank gets a lien over the goods, so they can retain possession of the goods if the importer doesn’t pay
What are bonds and indemnities?
For overseas trade, the buyer will often ask a bank for a bond or indemnity. This will act as a sort of insurance for the buyer.
E.g - You agree a bond/indemnity with a bank for a trade where you’ve imported goods, but the goods turn out to be faulty. As part of the bond, the bank must give you you’re money as soon as you say the seller has breached contract (warranty guarantee). The bank will then chase the seller for repayment (counter indemnity).
What is an Enterprise Finance Guarantee?
It is to help smaller business who may not have a great credit strength to get a loan
The government will secure up to 75% of the loan if the borrower defaults.
The borrower pays 2% premium fee for this service
What are the criteria for a business to be viable for Enterprise Finance Guarantee?
- Operate in the UK
- Turnover < £41m
- Tenor between 3months - 10 years
- Operate in a sector that is eligible for EFG
Which sectors are not eligible for Enterprise Finance Guarantee?
- Aquaculture (fish farming)
- Banking or any finance associated service
- Coal mining
- Commission agent
- Formal agent
- Insurance and associated services
- Public administration, defence, social security
