Financing Options Alternatives to Equity Financing

Overdraft - a form of lending where the bank grants a limit facility and the customer can take advantage of it as necessary. Essentially this is a form of unsecured short term financing. 

Advantages:

1. Typically cheaper than most sources of financing 

2. Interest is payable only on the amounts actually drawn which creates flexibility for the borrower and helps reduce costs. (especially for companies with fluctuating demand for WC) 

Disadvantages:

1. Overdrafts are typically payable on demand which increases the financial risk for the business

2. Longer-term overdrafts may be included in gearing ratios and banks could request security

Debt Factoring - an arrangement where the factor company advances a portion of the A/R to be collected and undertakes the admin functions of collecting the receivables

Advantages:

1. The factor company takes over client invoicing, sales accounting and debt collection and thereby  the client can reduce its own costs on the P&L

2. In certain circumstances the factor company will take over the risk of loss on the receivables, resulting in a transfer of credit risk on the A/R from the corporate to the factor company

3. Frees up capital that can be used to finance growth

4. Focus management time 

Disadvantages:

1. The level of finance is geared to sales volumes. Factoring does not resolve the WC requirements to finance growth since A/R always lag sales volume growth

2. Tends to be expensive relative to bank financing. Typically 2% of invoice value for service charges + bank rates for financing. 

3. May affect reputation with clients especially when clients pay directly to the factor company giving the impression that the company is facing financial troubles. 

Invoice Discounting - in this case a selected portion of the A/R is sold to a buyer at a discount. The Buyer does not undertake any administration of the client's sales ledger. 

1. Allows to raise capital from the A/R 

2. No security required. 

Disadvantages 

1. More expensive than any other source of financing that is likely available

2. Buyers will provide reasonable terms very often only on good quality receivabes 

Other sources of financing:

i. lengthening A/P days i.e. delaying payment

ii. Other loan financing

iii. More efficient inventory management 

iv. Early settlement discounts for customers