Short Term Financing:

For many small businesses, it is necessary to secure additional funds to cover expenses, or to
take the next step in growing the business. Before determining the best type of loan for the
business, however, it is important to clearly outline what kind of need the loan will fulfill.
Ascertaining what the money will be used for will help the borrowing business to choose the best
way to finance their need. Short term loans are a lending option that work for many businesses
that experience seasonal revenue fluctuations, or that otherwise require a small, quick loan to
cover expenses that will be repaid in projected revenue in under a year.

Most short-term financing options are tied directly to immediate sales; they are relatively easy to
qualify for as long as the business has a positive cash flow or outstanding invoices to use as
collateral. Short-term loans are rarely secured with a larger asset. As a consequence, however,
they are usually more expensive in terms of fees, interest rates and APR than longer-term loans,
and are generally available for smaller amounts than secured loans. Short-term financing is not a
recommended option for significant investments in the company – such as renting or purchasing
new space – due to shorter payback periods, lower loan amounts and more expensive financing.
For businesses that need additional capital for short-term inventory purchases or experience
seasonal spikes in revenue, however, short-term loans are a viable option.

Short-term financing options have more frequent payments than longer-term financing –
repayments are often taken out of daily sales, or require repayment within 30 to 90 days. In
comparison, longer-term loans are usually a fixed amount paid off at regular intervals, such as
biweekly or monthly.

There are several short-term financing models to choose from: a business line of credit, merchant
cash advances, and accounts receivable financing.

Short-Term Financing Options

Merchant Cash Advances are a viable option for businesses that have steady sales from debit
and credit cards, and are often the best opportunity available for business that lack collateral or
have too low of a credit score to qualify for a traditional loan. This route provides a cash advance
that is paid back via a percentage of the total credit and debit card sales each day until the entire
amount – plus fees – has been paid back. Although merchant cash advances are one of the most
expensive versions of short-term loans – depending on the daily sales amount, the APR can end
up in the triple digits – they do provide the advantage of being directly tied to sales. If the
business has a slow month, the amount paid toward the advance will be smaller as well.

Business Lines of Credit work much like a credit card and are a viable option for businesses
that need an ongoing source of working capital. They are best for businesses that have been in
operation for at least a year, with $60,000 or more in annual revenue. The business is given a
certain amount of credit to use, and are required to pay a small part of the balance due each
month. Interest is charged on the outstanding balance.

Accounts Receivable Invoicing, also referred to as invoice financing or factoring, allows the
business to borrow up to 90 percent of the amount they are owed in outstanding invoices. Invoice
financing is usually paid back within 30 to 90 days, and works best for growing businesses with
a positive cash flow that require flexible short-term financing. In accounts receivable invoicing,
the lender holds 10 to 50 percent of the loan amount in a reserve account. As soon as the invoice
is paid, the lender deducts the processing fee and factor fee, after which the remainder is turned
over to the business for use. The downside of this short-term loan option is that the factor fee is
generally charged on a weekly basis. Therefore, the longer it takes for the customer to pay the
invoice, the more costly the loan becomes for the business. Nevertheless, the outstanding
invoices act as the collateral for these loans, and obtaining them is relatively quick and easy.

Ultimately there are several options that are available to small businesses looking for short-term
solutions for covering expenses. Although these options may be higher interest than longer-term
loans, they are ideal solutions for businesses that have short-term gaps in their revenue or require
additional funds to increase inventory.

The Management of Inventory:

Significant amounts of working capital can be invested in inventories of raw materials, work-in-
progress and finished goods. Inventories of raw materials and work-inprogress can act as a buffer
between different stages of the production process, ensuring its smooth operation. Inventories of
finished goods allow the sales department to satisfy customer demand without unreasonable
delay and potential loss of sales. These benefits of holding inventory must be weighed against
any costs incurred, however, if optimal inventory levels are to be determined. Costs which may
be incurred in holding inventory include:

 Holding costs, such as insurance, rent and utility charges;

 Replacement costs, including the cost of obsolete inventory;
 The cost of the inventory itself;
 The opportunity cost of cash tied up in inventory

The economic order quantity:

This classical inventory management model calculates an optimum order size by balancing the
costs of holding inventory against the costs of ordering fresh supplies. This optimum order size is
the basis of a minimum cost procurement policy. The economic order quantity model assumes
that, for the period under consideration (usually one year), costs and demand are constant and
known with certainty. It is also called a deterministic model because it makes these steady-state
assumptions. It makes no allowance for the existence of buffer inventory.
If we assume a constant demand for inventory, holding costs will increase as average inventory
levels and order quantity increase, while ordering costs will decrease as order quantity increases
and the number of orders falls. The total cost is the sum of the annual holding cost and the annual
ordering cost. The total cost equation is therefore:

Total annual cost = Annual holding cost + Annual ordering cost

Buffer inventory and lead times:

There will usually be a delay between ordering and delivery, and this delay is known as lead
time. If demand and lead time are assumed to be constant, new inventory should be ordered
when the inventory in hand falls to a level equal to the demand during the lead time. For
example, if demand is 10 400 units per year and the lead time for delivery of an order is two
weeks, the amount used during the lead time is:

10 400 × (2/52) = 400 units

New inventory must be ordered when the level of inventory in hand falls to 400 units. If demand
or lead times are uncertain or variable, a company may choose to hold buffer inventory to reduce
or eliminate the possibility of running out of inventory. It could optimise the level of buffer
inventory by balancing holding costs against the potential costs of running out of inventory.

Just-in-time inventory policies:

Many companies in recent years have reduced inventory costs by minimising inventory levels.
The main purpose of a just-in-time (JIT) purchasing policy is to minimise or eliminate the time
which elapses between the delivery and use of inventory. Such policies have been applied in a
wide range of commercial operations and call for a close relationship between the supplier and
the purchaser of both raw materials and bought components. The purchaser requires guarantees
on both quality and reliability of delivery from the supplier in order to avoid disruptions to
production. In return for these commitments, the supplier can benefit from long-term purchase
agreements since a company adopting JIT purchasing methods will concentrate on dealing with
suppliers who are able to offer goods of the required quality at the required time. The purchaser
will benefit from a reduction in the costs of holding, ordering and handling inventory since
materials will move directly from reception to the production line The main purpose of a JIT
manufacturing policy is to minimise inventory acting as a buffer between different stages of
production. Apart from developing closer relationships with suppliers, this can also be achieved
by changing factory layout in order to reduce queues of work-in-progress and by reducing the
size of production batches. Good production planning is also essential if a JIT manufacturing
policy is to be successful.
The Management of Receivables:
A company’s credit management policy should help it maximise expected profits. It will need to
take into account its current and desired cash position, as well as its ability to satisfy expected
demand. To put the credit management policy into effect successfully, managers and staff may
need training or new staff may need to be recruited. Key variables affecting the level of
receivables will be the terms of sale prevailing in a company’s area of business and the ability of
the company to match and service comparable terms of sale. There is also a relationship between
the level of receivables and a company’s pricing policy: for example, it may choose to keep
selling prices relatively high while offering attractive terms for early payment. The effectiveness
of trade receivables follow-up procedures used will also influence the overall level of receivables
and the likelihood of bad debts arising. The trade receivables management policy formulated by
senior managers should also take into account the administrative costs of debt collection, the
ways in which the policy could be implemented effectively, and the costs and effects of easing
credit. It should balance the benefits to be gained from offering credit to customers against the
costs of doing so. Longer credit terms may increase turnover, but will also increase the risk of
bad debts. The cost of increased bad debts and the cost of any additional working capital
required should be less than the increased profits generated by the higher turnover. In order to
operate its trade receivables policy, a company needs to set up a credit analysis system, a credit
control system and a trade receivables collection system.

Credit analysis system:

To make a sensible decision about whether to trade with a company or not, information about the
business is needed. The risk of bad debts can be minimised if the creditworthiness of new
customers is carefully assessed before credit is granted and if the creditworthiness of existing
customers is reviewed on a regular basis. Relevant information can be obtained from a variety of
sources. New customers can be asked to provide bank references to confirm their financial
standing, and trade references to indicate satisfactory conduct of business affairs. Published
information, such as the audited annual report and accounts of a prospective customer, may also
provide a useful indication of creditworthiness. A company’s own experience of similar
companies will also be useful in forming a view on creditworthiness, as will the experience of
other companies within a group. A credit report may include a company profile, recent accounts,
financial ratios and industry comparisons, analysis of trading history, payment trends, types of
borrowing, previous financial problems and a credit limit. Bearing in mind the cost of assessing
creditworthiness, the magnitude of likely regular sales could be used as a guide to determine the
depth of the credit analysis.

Credit control system:

Once creditworthiness has been assessed and a credit limit agreed, the company should take
steps to ensure the customer keeps to the credit limit and the terms of trade. Customer accounts
should be kept within the agreed credit limit and credit granted should be reviewed periodically
to ensure that it remains appropriate. In order to encourage prompt payment, invoices and
statements should be carefully checked for accuracy and dispatched promptly. Under no
circumstances should customers who have exceeded their credit limits be able to obtain goods.
Trade receivables collection system :

Since the purpose of offering credit is to maximise profitability, the costs of debt collection
should not be allowed to exceed the amounts recovered. A company should prepare regularly an
aged trade receivables analysis and take steps to chase late payers. It is helpful to establish clear
procedures for chasing late payers, to set out the circumstances under which credit control staff
should send out reminders and initiate legal proceedings. Some thought could also be given to
charging interest on overdue accounts to encourage timely payment, depending on the likely
response of customers.

Insuring against bad debts :

Insurance against the risk of bad debts is available and can be arranged through brokers or
intermediaries. Whole turnover insurance will cover any debt below an agreed amount against
the risk of non-payment. Specific account insurance will allow a company to insure key accounts
against default and may be used for major customers.

Discounts for early payment:

Cash discounts may encourage early payment, but the cost of such discounts must be less than
the total financing savings resulting from lower trade receivables balances, any administrative or
financing savings arising from shorter trade receivables collection periods, and any benefits from
lower bad debts.

Invoice discounting:

Invoice discounting involves the sale of selected invoices to a third party while retaining
full control over the sales ledger; it is a service often provided by factoring companies.
The main cost of invoice discounting is a discount charge linked to bank base rates,
although a fee of between 0.2 per cent and 0.5 per cent of turnover is often levied.
Invoice discounting is useful to a company because it results in an improvement in cash
flow. Evaluating the costs and benefits of factoring and invoice discounting is similar to
evaluating discounts for early payment, as discussed earlier
Managing Accounts Payable:
No what matter what size your business is, paying bills will always be part of it. Whether it’s the
occasional order to pay for or a fully staffed accounts payable department managing thousands of
invoices. By implementing best business practices you can streamline your accounts payable
process and be prepared for future growth. Below are 5 tips to help you successfully manage
your accounts payable:

1. Simplify Your Accounts Payable Process:

 Reduce the number of check runs; two per month at most is plenty.

 When the accounting staff prepares check runs, they should have the invoice backup
ready and invoices approved by the appropriate department heads before coming to you
for signatures.

 Make Accounts Payable aware of any cash disbursement ceilings for each check run so
they can then select the most important invoices to pay.

 Empower your staff with decisions that will make your life easier and are not dangerous
for them to make. The decision to make partial payments on larger balances, or delaying
payments to vendors who have a higher tolerance on due dates are a couple of examples.

2. Use Technology:

 Analyze and reduce errors such as paying incorrect amounts, incorrectly entering check
numbers used to pay vendors, and paying too early or too late.

 Make sure your accounts payable module is set up correctly so that transactions flow
properly. You may need to use a consultant to make sure your accounting software and
accounts payable module are correctly configured, or you could cause more problems
than you solve.

 Have Accounts Payable staff enter terms for each vendor in which the system can default
to, such as Net 30, Net 60, etc. Terms are often provided by the vendor, and are usually
printed on the face of their invoice.

 Run aging reports so you know what is in the pipeline. You may have a small check run
this period, but could have a large one coming up that you didn’t know about until
looking at these reports.

 Use laser printed checks, which will update the system automatically, marking which
invoices have been paid and with what check numbers.

3. Reduce Accounts Payable Fraud:

  Anywhere cash/checks are handled (incoming or outgoing) can be a high-risk area for
company fraud.

 In Accounts Payable, this is often accomplished by setting up a “dummy vendor”. Often

times, this vendor is a company owned by a dishonest employee. Invoices for services
never provided are created, and your business pays these invoices, essentially paying the
employee.

 Implement policies & procedures to mitigate the risk. In the above example, have system
parameters set so that the person cutting checks does not have the ability to set up new
vendors. Each new vendor that is set up should require explanation to the owner prior to
creating them.

 Separation of duties, proper approval by department heads, and spot checks will help
reduce the risk of fraud.

4. Vendor Terms May Be Negotiable:

 Usually invoices will come with Net 30, Net 60, 2%10 Net 30, etc.

 Regardless of the terms given, you can call your vendors and negotiate terms for your
own company.

 Vendors will often give discounts or special terms to customers that purchase large
volumes and on a regular basis.

 Even if the normal terms can’t be changed, if you run into an issue and must pay late, it’s
best to call and discuss it with your vendor rather than avoiding them.

5. Reduce CFO Impact to Verification & Signature:

 Typically the CFO signs checks but should not be assembling the check run.

 Accounts Payable should run the aging, choose which invoices to pay, assemble the
invoices, print the checks, and verify that all invoices are approved before bringing them
to the CFO.

 CFO simply checks the invoice amounts against the check before signing.

 If your company manages cash more actively, let Accounts Payable know up front what
their “budget” is. They will know best what vendors can wait until the next check run.