If a business cannot obtain all of its desired funding from banks, it is likely and logical that the business will turn to alternative sources of funds.
Trade Credit plays a critical role in strengthening bank relationships and the major advantages of having a Paydex and Intelliscore of 80 or better with several qualified trade lines reporting to Dun & Bradstreet and Experian Business are:
1. Better chance of loan approval
2. Typically approved for higher dollar amounts
3. Lower interest rates on loans and credit lines
Trade Credit is a substantial part of the Optimal Financing Mix… A Small Business survey conducted by the National Federation of Independent Business (NFIB) asked respondents to rank Source of Funds in order of importance:
1. Credit Cards
2. Trade Credit / Vendor Credit
3. Bank Loans & Credit Lines
4. Retained Earnings (Profits)
The role of Trade Credit in a Business’s capital structure can play a vital role in managing cash flow especially when bank loans or credit lines are not available.
Here are some other characteristics of Trade Credit:
• Trade Credit can be used to finance a portion of a firm’s investments in inventory or accounts receivable.
• Trade Credit allows a business to better match the timing of cash outlays for the cost of goods sold with the cash receipts from sales.
• Trade Credit plays a critical role in a firm’s quality control efforts by allowing them to verify product quality before paying.
• Due to its revolving nature, a business can find it less costly to delay Trade Credit payments than to renegotiate the payment terms of bank loans.
• Delayed Trade Credit payments could help fund capital investments.
• Suppliers encourage early payment with incentives, such as discounts for invoices paid within a certain time.
• Terms are usually Net 30 or Revolving.
• Revolving terms are much more valuable and desirable since you do not have to pay the balance in full.
• There's virtually no end to the number of vendors you could establish trade accounts with. The only catch is that not all businesses offer these types of business credit accounts.
• Net 30 terms basically have no "cost" but could assess fees in some cases if they are not paid within the 30 days. Some offer 2% discounts if the invoice is paid within 10 days.
• Companies that issue trade credit with revolving terms typically has high APR's or annual percentage rates. Companies like Dell, Staples, Home Depot, Wal-Mart, Exxon, and Shell all offer revolving terms and you'll likely see APR's from 14-29%.
• With trade credit, your personal credit profile and scores are typically less important and often times irrelevant.
• You can obtain trade credit as a new business, although it is more challenging and does require a plan or a strategy that knows which businesses to set these accounts up with first.
• You will rarely need full financials to establish trade credit.
Trade Credit is the easiest of the 3 UBL's to obtain. Getting favorable terms can be invaluable for you as you build your business. It's also important to note that favorable terms should be thought of in terms of the cash-flow more than the interest rate. In other words, would you prefer a rate of 13% with a lower monthly payment, or a rate of 9% with a much higher monthly payment? Most people would like the lower payment s. Look for "cash-flow friendly" financing as you're seeking your capital.
The second (2) type of “UBL” is the Business Credit Card. Business credit cards are the most commonly used form of financing for small business owners, in fact, there's not really even a close second since credit card financing is so far ahead of all other forms of borrowing in the small business sector. According to the Meredith Whitney Advisory Group, 82% of small business owners use credit cards as a "vital part" of their overall funding strategy. Also, according to NFIB, 79% of small business owners use credit cards.
Here are some characteristics and facts about Business Credit Cards:
• Although there are some rare (and we mean "VERY rare") exceptions, business credit cards will require a PG or Personal Guarantee so don't buy the hype that a business credit card doesn't require a PG.
• Most business credit cards come with 0% intro offers. Not all of them, but most do.
• According to creditcards.com the national average interest rate for business credit cards is 12.98% (as of July 2, 2013).
• Our internal case study found that the clients we polled were paying blended rates between 5.0 - 8.96% on their business credit cards and these are all based on rates AFTER the 0% introductory offers expired.
• Business credit cards, when the right ones are used and properly set up, allow you to separate your business and personal credit.
• Keybridge Research did a 5 year study to learn how the use of business credit cards impacted revenue growth and job creation for small businesses. Click here for the study.
a) For every $1,000 spent on a business credit card there is a corresponding increase of about $5,500 in annual revenues.
b) Between 2003 - 2008 the increase in business credit card usage contributed to the creation of 1.6 million US jobs.
• Don't believe the hype when uninformed people recommend using personal cards for business purposes. This is usually recommended by people who think that the protections of the CARD Act outweigh the wisdom of separating your personal and business credit.
• Your personal credit is very important and will be looked at as part of the underwriting process in order to get approved.
• You can be a startup business that has not made money and still get business credit cards.
• It is rare for lenders to request full financials as part of their approval process.
• When originated and obtained properly you can actually protect, preserve, and improve your personal credit profile and FICO scores while borrowing money for your business. It's the best of both worlds.
• Credit card financing is what we call "cash-flow friendly"… what we mean is that the required monthly payment is about as minimal as you can find with any kind of financing solution. Since we all say that Cash-Flow is King we can't forget that when we borrow money. Example: If you borrow $50,000 would you rather pay back $3,000/month or would you prefer the flexibility of paying as much as you want with a minimum required payment of $1000/month?
The third (3) and final type of “UBL” is the Traditional Bank Line of Credit or Unsecured Bank Draft Line of Credit (UBD). These are the larger UBL's that tend to normally be between $50,000 - $100,000 and can sometimes go as high as $250,000. Business lines of credit rarely go above $250,000 without collateral. Keep in mind, A LOT of people will say they offer these for over $100,000 or over $250,000 but what they are going to give you will come with a UCC filing. A UCC is a lien just like a mortgage is a lien. Any business loan or business line of credit that comes with a UCC filing is not unsecured. That doesn't mean it's bad, it just means it's not unsecured.
Here are some characteristics of Traditional UBL’s & Unsecured Bank Draft Lines of Credit:
• Very difficult to obtain but also the most sought-after of the 3 kinds of UBL's.
• Terms are usually anywhere from Prime + 1% to Prime + 6%.
• These are probably the #1 product in small business banking portfolios that get reviewed or taken away when a bank is in trouble or looking to clean up their balance sheet.
• All owners of the business who own at least 20% of the business will probably need to have very good personal credit.
• You will need to be in business for at least 2 years, the longer the better.
• You probably need to have revenues of $400-500k in your last taxable year - meaning those tax returns need to have already been filed - in order for these to even be possible.
• In most cases you'll need to submit full financial packages to the lender or lenders.
• You cannot be in high-risk industries like restaurants, real estate development, or retail in nature.
• Upon approval the banks will issue you a book of checks and attach your unsecured business line of credit to your checking account. You can draw on the money as needed for working capital, financing receivables, or a variety of other business needs as they arise.
• Most lenders, when originating these business lines of credit without collateral, will go "up to" 10-15% of your gross revenues and will limit the total amount of the line of credit to a cap. Caps are most of the time between $50,000 - $100,000.
These UBD’s or Traditional Bank Lines of Credit are the most difficult to obtain due to the combination of only a minimal number of banks offering them and the revenue/seasoning requirements. Keep in mind that only about 11% of the 25-30 million small businesses in the U.S. have done over $300,000 in annual revenues. Then when you pull out the small business owners who do not have good personal credit and the high risk industries and you can see that this is only for a chosen few.
There are 3 big reasons, in order, why many business owners cannot get these $100,000 lines of credit:
1. They are a start-up with no financials or they have not grown their business to the revenue levels required.
2. They are in a high risk industry (real estate, restaurants, retail).
3. Their personal credit is damaged and/or they did not build business credit.
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The first (1) type of “UBL” or Unsecured Business Line of Credit we talk about is commonly known as Trade Credit or Vendor Credit. These credit lines are issued by different companies and suppliers that offer revolving accounts only good with their business. Home Depot, Office Max, Lowes, Chevron, Dell are some of the more recognizable names; there are literally thousands of vendors offering credit to businesses every day. Here’s an example: You're a plumber working on a commercial job and you need 3 large rooftop air conditioners to be installed at the school you're working at; you pick up the units from ABC Plumbing Supply and they invoice your company expecting payment for the units within 30 days. That's Trade Credit. It's normal. It's common. It’s used thousands of times every single day by businesses of all shapes and sizes.
Business Loans vs. Business Lines of Credit
Here are 8 ways in which loans are different from lines of credit:
1. Business loans are used one time whereas lines of credit can be used multiple times.
2. "When" you get a loan is different from "when" you get a line of credit. A loan is normally not something you would get until you need it because it's normally for one specific purpose. A line of credit is something you obtain before you need it. Remember the line of credit, unlike a loan, is not for one specific purpose.
3. With a loan you have a monthly payment that, although there are a few exceptions, doesn't change from month to month and those monthly payments begin right away. Whether or not you're using all of the money your monthly payment does not change. With a line of credit you only make payments on the amount of money you've borrowed so if your balance is zero your payment is zero.
4. The closing costs are higher for a loan than a line of credit. There are always exceptions to every rule but most loans carry closing costs anywhere from 3-7% whereas lines of credit have very minimal or no closing costs.
5. Loans carry with them fixed terms or amortization periods. Because of this the monthly payments on loans are usually higher than the monthly payments on lines of credit. If you were to get a loan for $50,000 your monthly payment will likely be $500-1,500/month more than it would be if you owed $50,000 on a line or lines of credit.
6. Loans are usually best for long-term debt that gets paid off over 2 to 6 years. Lines of credit, however, are best for short-term purposes such as financing receivables, marketing, and making payroll. We acknowledge that lines of credit are great for unexpected cash-flow issues but make sure you don't exhaust your lines of credit. Use as much of your line of credit for what we call RGA - Revenue Generating Activities. If you use some of your funds for a marketing initiative (or several of them) then you'll likely be able to justify the new debt you've incurred because you've also generated additional revenue and grown your organization.
7. Business loans have higher interest rates but they are normally fixed rates. Business lines of credit normally have lower interest rates but are variable. This simply means that if you manage your lines of credit poorly by making late payments or going over the credit line then - from an interest rate perspective - you would have been better off getting a loan. With a line of credit the rate can actually get better with good credit management.
8. Loans are usually somewhat interest-rate driven, whereas lines of credit are not as rate-sensitive. With a line of credit, that is used primarily for short-term purposes, it's more important to have a monthly payment that is "cash-flow friendly" and, even though the rates are normally quite good, it's more important that the line can be used repeatedly and the monthly payment is as low as possible in relation to the balance.
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