Essential Business Financing Methods

Trade Credit: Supplier Financing Basics

Trade credit from suppliers is a form of financing offered by suppliers, allowing businesses to defer payment for goods or services for a specified period, typically 30, 60, 90 days, or even longer. It usually involves no explicit interest, offering a more automatic, continuous, and agile process. Once an agreement is established with a vendor for deferred payment, it generally doesn't require constant renewal.

However, a common issue with trade credit is that companies sometimes overlook its implicit cost: the opportunity cost of not taking advantage of potential discounts offered by suppliers for immediate payment.

Bill Discounting: Accelerating Cash Flow

Bill discounting is a financing operation that originates when a company makes a credit sale, meaning the client has a grace period to pay. This right to collect is typically documented in a commercial instrument, such as a bill of exchange or promissory note. The company then has the right to present this instrument to a bank for early payment before its maturity date. The operation to transfer this instrument to the bank is called endorsement.

How Bill Discounting Works

When a company endorses a bill to the bank, two main scenarios can occur:

• The most desirable outcome is that the customer pays the bank directly on the maturity date, fulfilling their obligation.
• If the client does not pay on the maturity date, the bank will return the unpaid instrument to the company. The company then becomes responsible for claiming the payment from the customer, and the bank will debit the amount previously advanced from the company's account. (Note: The full face value of the instrument may not be debited, as the bank's fees/interest would have already been accounted for).

If the operation goes wrong and the customer does not pay the bank, the bank returns the unpaid instrument to the company and debits the company's account (e.g., €970). The company then becomes responsible for collecting the debt.

Costs Associated with Bill Discounting

Bill discounting operations typically involve the following costs:

1. Interest: Calculated based on the number of days the company requests the advance payment (longer periods incur higher interest).
2. Commission: A percentage of the nominal value of the bill.
3. Stamp Duty: A tax levied on these financial transactions.

Factoring: Selling Your Receivables

Factoring is a type of financing that involves selling a company's accounts receivable (invoices) to a third party, known as a 'factor,' in exchange for immediate cash. The factor then assumes the right to collect the debts from the clients. A key difference from bill discounting is that with factoring, there isn't necessarily a physical instrument like a bill of exchange. In factoring, the factor (often a bank or financial institution) typically assumes the credit risk of non-payment by the client.

Because the factor assumes the risk of non-payment, the cost of factoring is generally higher than that of bill discounting.

Factoring Advantages and Disadvantages

• Advantages for the Company: It provides rapid access to financing without credit risk (in non-recourse factoring). The factor's profit is the difference between the amount they pay the company and the amount they collect from the client.
• Disadvantages for the Company: The company loses control over its receivables (a portion of its realizable assets). The factor assumes the risk of client non-payment.

Renting (Operating Lease): Asset Acquisition

Renting (also known as an Operating Lease) is a long-term financing source that involves hiring an asset for a specified period. The rental agreement typically includes maintenance, taxes, and insurance. It differs from financial leasing in that renting usually does not offer an option to purchase the asset at the end of the term.

Benefits of Renting for Businesses

• It is commonly used for machinery, equipment, vehicles, and other assets.
• It is generally fully tax-deductible (leading to lower tax payments). (Note: For certain assets like passenger cars, deductibility might be limited, e.g., 50%).
• It frees up company capital for other investments, as the asset is not owned and does not appear as debt on the balance sheet.
• All associated costs (e.g., insurance, maintenance) are often unified into a single rental invoice.
• Renting typically does not negatively impact the company's debt-to-equity ratio.