Where can I get financing from?

You are probably deliberating on seeking funding from a bank or other financial institutions. Maybe it’s to finance purchase of fixed assets, restock inventory or to meet general operational expenses. Before sourcing out for financing you need to ask yourself, ‘do I need this money?’ Here’s an article to help you think: You don’t need additional financing and this is why!. If you however must take on credit, this article will help you structure your thoughts on sourcing funds.

Retained Earnings

Retained earnings is the amount of net income left in the company after dividends have been paid out to shareholders. From retained earnings, the company can use this to finance any new ventures and investments in the coming periods. Some companies also opt not to pay dividends; especially if they anticipate a more lucrative investment opportunity from which the company can gain more revenues. This is the most common internal source of funds in any business.

Payables & Received Prepayments

Payables are debts the company owes that arise from goods and services received on credit. Received prepayments occur when customers settle an account or pay an amount before the service is rendered or goods are sold. Both are different from other external sources of funding because they incur no interest.

This source of funding is short-term, ranging between 30 days and 90 days. The business can therefore only invest in projects that are equally liquid (pay back within a similar time frame). Buying assets, paying operating expenses or investing in other less liquid activities is dangerous and often results in insolvency.[1]

Bank Overdraft

This is an extension of credit from a lending institution that is granted when your account balance reaches zero. Simply put; your cheques never bounce. Overdraft facilities are short term and range between 3 months to 1 year but can be renewed at the end of the period. The business pays interest on the highest overdrawn amount at the end of every month.

The overdraft amount offered to each client varies and is dependent on monthly cash inflows and outflows. The bank normally looks at monthly cash sales before deciding on the overdraft limit. It is worth noting that even though this facility offers convenience and peace of mind, it is an extremely expensive line of credit because interest is paid monthly and a maintenance fee is also charged for the facility.

Business owners are advised to properly understand cash movements in their business before applying for this facility. Banks often discontinue an overdraft facility if the client does not frequently use it.

Invoice Discounting

Invoice discounting is a practice where a company uses its outstanding receivables as collateral for a loan. Invoice discounting essentially accelerates cash flow from customers, so that instead of waiting for them to pay within their normal credit terms, you receive cash almost as soon as you issue the invoice.

It is extremely short-term (approximately less than 90 days) and improves the liquidity position of the business. The business may however be in trouble if it does not collect the receivables within the period matching the credit facility. Invoice discounting works best for companies with relatively high profit margins, since they can easily cover the high interest charges associated with this form of financing. High fees and interest charged, coupled with a short repayment period on this facility makes it a last resort source of financing.

Asset Financing

Asset financing refers to the use of a company’s balance sheet assets including current assets[2] to get a loan. Asset financing is most often used when a borrower needs a short-term cash loan or wants to finance working capital such as cash to pay salaries, purchase the raw materials or other expenses.

Hire Purchase or Leasing Contract

This is a contractual agreement requiring the user of an asset, to pay the owner of the asset for the use of his/her asset. Common assets that are leased include building, vehicles and business equipment. Asset ownership may or may not be transferred at the end of the leasing period. This agreement helps the business to rather than pay the full amount of the asset, pay a much smaller amount in periodic installments, yet gain access to the usage of the asset.

Term loans

This the most common form of borrowing in Kenya. A term loan is a specific amount of money that is borrowed from a lending institution, that has a specified repayment schedule, and an interest charge. Term loans may range from 1–30 years. The interest charged is dependent on the net amount received after deduction of all fees associated to acquiring the loan. The instalment amount, number of instalments, repayment period, repayment frequency, contractual savings requirement and any penalties resulting from delayed payments are important details to understand before agreeing to the terms and conditions. Term loans can be used to purchase long-term assets because they afford the borrower a longer repayment period.

Venture Funding

This is a form of financing that is provided by firms or funds to small, early-stage, emerging firms that are deemed to have high growth potential, or which have demonstrated high growth. Venture funding is normally used to accelerate growth. Venture Capitalist’s (VCs) take on the risk of financing risky start-ups in the hopes that some of the firms they support will become successful. VCs provide this financing in the interest of generating a return through an eventual exit.

SMEs should strive to get such forms of funding because; apart from money, VCs bring in expertise, networks and strategies that would propel growth in the business. This is much more advantageous than bank loans. VCs may however require some equity and control of the company.

Other alternative sources of funding include: Peer to Peer lending, crowdfunding, angel investors, issuing IPOs etc. These sources are however not prominent in Kenya, but they are worth a look.

Parting shot

All funding institutions require proper financial records from the start. This helps them analyze the capacity of the business and properly come up with a solution that will benefit both parties. It is therefore recommended that businesses keep accurate and real-time financial statements i.e. at least the Balance Sheet, Profit & Loss and Cash-flow Statements. The ISBI Institute has developed an in-house solution (Reka Initiative) to solve this challenge.

Additionally, if you are in search of equity financing, we will be hosting a Capital Raising Seminar on the 22nd & 23rd of August at Strathmore Business School to enlighten entrepreneurs on how to best structure their efforts.

[1] Insolvency is the inability to pay debts when they are due.

[2] Current assets are assets that can easily be converted to cash within 12 months. They include: cash, short-term investments, receivables, prepaid expenses, and inventory.