Operating a business can be really challenging. When business environment is unfavourable, business owners become stressful due to possible slowdown in sales, high operating expenses, among other burning issues. The business owners need to attend to these issues promptly in ensuring effective resolutions, otherwise the issues may amplify and make things worse.
However, when business environment becomes conducive and robust, business owners face a different set of challenges. This time they need to work even harder to ensure that the business can cope with the increasing demand for its products and services. They must also strive to ensure that the businesses have sufficient cash or financing to fund their increased business volume.
This issue, though may be seen as a good problem, can pose real challenge to many businesses.
Essence of Trading Cycle
When businesses embark on their journey for expansion, there are many areas where businesses need to work on. One of the key critical areas is the additional funding needed to support the growing business. And this incremental funding can either be sourced internally or most often, from banks. Let’s review the typical trading cycle of a business to better understand the working capital and fixed assets financing requirements:
With exception to trade creditors where businesses receive goods or services without the need to make immediate payment, all the other aspects of the trading cycle require funding from the business. This means, when the businesses expanded, there is a need for more cash to funds the business operations. This can be in the form of internal cash or financing from the banks or shareholders.
In addition to working capital, businesses may need to increase their production and warehousing capacity to cope with the increased volume. This again attracts more funding requirement. In short, businesses need to raise their cashflow to cater for business expansion.
Purpose of Financing
In any business, large and small, the funding and risk management requirements are rather similar, only different in terms of the quantum of requirement. Generally, the financing and services required by businesses can be categorized into three broad areas as follow:
Incremental Working Capital
When businesses expanded their sales, they are directly expanding their trading cycle. In accommodating the higher business volume, they need to maintain higher stock, produce more products and perhaps provide higher credit to their buyers. All these activities impact their cashflow, hence can strain their working capital. Unless the businesses maintain sufficient cash to finance the incremental cashflow, otherwise they would need to seek financing from banks.
Acquisition of Fixed Assets
When businesses need more space or additional machinery to cater for the increasing business volume, they would have to invest on additional fixed assets. This investment is longer term in nature as compared with working capital which is short term in nature. Businesses would normally seek medium or long-term financing from banks or leasing companies to finance the acquisition of fixed assets.
Protection Against Risks
In addition to financing requirement, businesses may expose themselves to other risks when they expand their business across the borders. Foreign currency risk can pose serious risk to the businesses when it is not properly managed. Leaving the foreign currency exposure open can easily wiped out the business profits. Besides foreign exchange risk, businesses will also be exposed to damages of their fixed assets like business premises and machinery. Businesses must ensure that their fixed assets are properly insured against any untoward incidences in the future.
Type of Financing
As briefly mentioned earlier, there are various types of financing where businesses can choose from. Financing can be classified based on their respective usage, modes of operation and tenors of the facility:
The most flexible type of short-term financing offered by banks is overdraft. Businesses can draw on this facility anytime, anyhow without much control from the bank. It is due to this reason that banks are often reluctant to offer high overdraft limit to businesses. The interest for overdraft is often higher than most other forms of financing.
The other more common form of working capital financing is trade facility. Trade facility covers a broad spectrum of products, ranging from Banker’s Acceptance to Trust Receipt to Invoice Financing, among others. The utilisation of this facility is less flexible as compared with overdraft.
Trade facility requires supporting documents like invoice for purchases, shipping documents, etc that can validate the commercial transactions, hence the requirement for financing. The advantage of this facility would be its relatively low pricing as compared with that of the overdraft. Banks prefer to offer trade financing to businesses due to the extent of control on the usage.
Medium & Long-term Facilities
In the course of business expansion, businesses may acquire new factories, warehouses or machinery to support the increased business volume. These are catogorised as long-term assets. These types of fixed assets can be financed by term loan, hire purchase or leasing which are long term in nature. These long-term financing are normally repaid by monthly instalments over 3-10 years.
Insurance & Foreign Currency Hedging
Protection for fixed assets and even loss of income due to untoward incidences is important for businesses. There are various types of insurance coverage that are applicable for different purposes. Besides protection for assets, businesses that transact in foreign currencies can also consider hedging of foreign currency to better manage the currency fluctuation. The hedging products would help businesses to protect themselves from currency fluctuation.
Engaging The Bankers
In anticipation of eventual financing needs from the banks, businesses should start to engage their bankers early. They should not only meet up with their bankers when they need financing from them. Businesses should make it a point to embrace their bankers and keep their bankers informed of their business operations. Knowing the bankers is crucial for the bankers to extend their advice on financial management to the business. Gaining the banker’s trust and understanding of the business is essential too.
When businesses need to seek for financing from the bankers, they must be able to submit the necessary information and documents to the bankers for evaluation. A well written and thorough business plan together with proposal for financing requirement will be useful to the bankers. Therefore, it is worth the effort and time for businesses to work on and produce a proper business plan.
BY EDDIE HU