Doing business with the bank: Which type of finance is right for my business?

Standard acknowledgements of debt and the National Credit Act (NCA)
October 21, 2015
Sake met die bank: Watter tipe finansiering is reg vir my besigheid?
October 21, 2015

Doing business with the bank: Which type of finance is right for my business?

Getting finance for your business is not just about getting the money. Keep in mind that sometime or another the business will have to pay the money back to the lender. Choosing the right type of finance will depend on what you need the money for, how much you need and how you can pay it back. A few of the most used funding options in South Africa are discussed below.

1. Overdraft

If your business has a cheque account, you can apply for an overdraft facility. Normally you have three options:

  • Standard option – The overdraft is reviewed annually and the limit is pre-approved for the next twelve months;
  • Reducing option – The maximum limit on the overdraft facility is reduced every month until you have paid back the full amount;
  • Temporary option – The overdraft is granted for a fixed time period and must be paid back in full at the end of that period.

The interest rate on an overdraft is usually linked to the prime rate and negotiable. An overdraft facility is a short-term financing option and you pay interest only on the amount you actually withdrew.

2. Revolving credit plan

A revolving credit plan is an ongoing loan for a pre-approved amount. Once you have repaid the loan up to a certain amount (usually 25%), you can re-borrow money on the loan up to the pre-approved amount without having to re-apply when you want to withdraw funds again. The interest rate is linked to the risk profile of your business and the prime rate. It is easy to plan your cash flow as the monthly repayments are fixed.

Revolving credit is an ideal short to medium term financing option if your business regularly needs additional funds.

3. Business mortgage

A business mortgage is used to buy residential property which have business rights. The business mortgage is paid back to the bank over a maximum period of 20 years. There is some space for negotiating about the interest rate with the bank as the interest rates differ from bank to bank.

4. Credit card

You can get up to 55 days interest free credit when you buy items on your credit card. The bank will indicate what the full amount is you have to repay and by which date. If you repay the full amount by the due date you will not pay any interest. You will also have the option of making a minimum payment. The outstanding balance will carry interest for as long as it remains due. Interest rates on credit cards are among the highest and not paying the full amount when it is due can make for a very expensive form of finance.

Make sure to read the agreement with the bank before you sign, as the small print may state that you are personally liable for the business’s credit card debt if the business fails to repay the outstanding amount to the bank.

Apart from potential interest, credit cards usually offer benefits like high credit limits, reward programs and low transaction costs.

5. Debtor finance (Factoring)

You can “sell” your business’s outstanding debtors (clients who owe you money) to a bank at a discount and they will then collect the money from the clients on your behalf at a fee. The bank will advance you for example 80% of the value of an invoice, provided the work has been completed and the goods have been delivered.

6. Term loan

The repayment options on a term loan are determined by the period over which your business can repay the bank, usually up to a maximum of eight years, unless you make a different arrangement with your bank. A term loan must be guaranteed by collateral and the value of the collateral you can provide will determine the amount of the loan. The interest rate is usually linked to the prime interest rate.

Repayments are done in equal monthly payments, the amount and timing of which can be planned to suit your business and its cash flow. Instalment plans can be arranged for the payment of monthly, bi-monthly, quarterly or annual instalments and you can make extra repayments on the loan.

Term loans are a medium to long term finance option and normally used to finance big capital expenses.

A wrong financing decision can have material negative consequences for your business and potentially cause serious cash flow problems, while making use of the financing option best suited to the unique requirements of your business can make your business flourish. It is always a good idea to shop around and negotiate the best possible terms before committing to borrow money.

If you would like additional information or professional advice on how to finance your business through debt, please contact our offices.

Reference List:

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. (E&OE)

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