Closing a cash flow gap: short-term funding options compared

Closing a cash flow gap is a common challenge many South African small to medium-sized enterprises (SMEs) face, particularly when dealing with 30 to 60 day payment terms from clients, while having to pay suppliers and staff on time. The problem is exacerbated by load-shedding, which can disrupt production and impact cash flow. In this article, we will explore short-term funding options compared, to help SME owners become funding ready and match them with the right lenders.

According to the Small Enterprise Finance Agency (SEFA), many SMEs struggle to access funding from traditional banks, due to stringent credit requirements and high collateral demands. This leaves a significant gap in the market, which alternative funding platforms, such as Business Funds, are trying to fill. As an SME owner, it is essential to understand the different short-term funding options available, to make informed decisions about your business.

Understanding short-term funding options

Short-term funding options are designed to provide SMEs with quick access to cash, to bridge the gap between payment cycles. These options typically have shorter repayment terms, ranging from a few months to a year, and are often used to cover immediate expenses, such as payroll, rent, or inventory purchases. The most common short-term funding options include overdraft facilities, short-term loans, and invoice financing.

An overdraft facility allows SMEs to withdraw more money from their business account than they have, up to a predetermined limit. For example, if an SME has an overdraft facility of R100 000, they can withdraw up to R100 000, even if their account balance is zero. The interest rate on overdraft facilities can be high, typically ranging from 15% to 25% per annum, and the repayment term is usually short, ranging from a few months to a year.

A short-term loan, on the other hand, provides SMEs with a lump sum of cash, which is repaid over a set period, typically ranging from 3 to 12 months. The interest rate on short-term loans can be high, typically ranging from 20% to 30% per annum, and the repayment terms can be strict, with penalties for late payments.

Invoice financing: a viable short-term funding option

Invoice financing, also known as factoring, allows SMEs to sell their outstanding invoices to a third-party lender, in exchange for immediate cash. The lender then collects the payment from the client, minus a fee, which can range from 10% to 20% of the invoice value. Invoice financing can provide SMEs with quick access to cash, without the need for collateral or a long credit history.

For example, if an SME has an outstanding invoice of R50 000, they can sell it to a lender for R40 000, and receive the cash immediately. The lender then collects the full R50 000 from the client, and returns the remaining R10 000 to the SME, minus their fee. This can be a viable short-term funding option, particularly for SMEs with a high volume of outstanding invoices.

A worked example: comparing short-term funding options

Let’s consider an example of an SME, ABC Pty Ltd, which needs to cover a cash flow gap of R200 000, to pay staff and suppliers. They have three short-term funding options: an overdraft facility, a short-term loan, and invoice financing. The overdraft facility has an interest rate of 20% per annum, and a repayment term of 6 months. The short-term loan has an interest rate of 25% per annum, and a repayment term of 3 months. The invoice financing option has a fee of 15% of the invoice value, and a repayment term of 30 days.

The total cost of the overdraft facility would be R40 000, over 6 months, which is R6 667 per month. The total cost of the short-term loan would be R50 000, over 3 months, which is R16 667 per month. The total cost of the invoice financing option would be R30 000, over 30 days, which is R1 000 per day.

In this example, the invoice financing option is the most cost-effective, as it provides quick access to cash, with a lower total cost. However, the SME needs to consider the fees and repayment terms of each option, to make an informed decision.

How to apply for short-term funding

To apply for short-term funding, SMEs need to prepare their financial documents, including their balance sheet, income statement, and cash flow statement. They also need to provide information about their business, including their credit history, and outstanding invoices. The application process typically involves the following steps:

• Registering on the funding platform, and providing basic business information
• Uploading financial documents, and providing additional information about the business
• Receiving a quote, and reviewing the terms and conditions of the funding option
• Accepting the quote, and receiving the funds

It is essential to note that the application process may vary, depending on the funding platform, and the type of funding option. SMEs should also be aware of the Companies and Intellectual Property Commission (CIPC) requirements, and the South African Revenue Service (SARS) tax implications, when applying for short-term funding.

Common mistakes to avoid when applying for short-term funding

When applying for short-term funding, SMEs should avoid common mistakes, such as not reading the terms and conditions, and not understanding the fees and repayment terms. They should also avoid applying for multiple funding options, at the same time, as this can negatively impact their credit score. Additionally, SMEs should ensure that they have a clear understanding of their business financials, and can provide accurate information to the lender.

SMEs should also be aware of the Protection of Personal Information Act (POPIA), and the Broad-Based Black Economic Empowerment (B-BBEE) requirements, when applying for short-term funding. By avoiding these common mistakes, SMEs can increase their chances of approval, and ensure that they receive the funding they need to grow their business.

A short checklist for SMEs

Before applying for short-term funding, SMEs should consider the following checklist:

• Do you have a clear understanding of your business financials?
• Do you have a solid credit history?
• Do you have outstanding invoices, that can be used for invoice financing?
• Do you understand the fees and repayment terms of the funding option?
• Do you have a plan, to repay the funding, within the specified term?

By considering these factors, SMEs can make informed decisions about their short-term funding options, and ensure that they receive the funding they need to grow their business. If you are an SME owner, looking for short-term funding options, see if your business qualifies for funding in 60 seconds, and take the first step towards closing your cash flow gap.