Short-Term Financing: Financing Strategies for When Your Working Capital Needs
Every business owner has been there before.
That moment when you realize you need financial capital fast, and your bank account is just not going to cut it. Whether it's for an unexpected expense or to take advantage of an opportunity, sometimes you really need short-term financing. But what are your options? Getting funding is already hard enough, especially for women in business.
Fortunately, short-term financing options can help you bridge the gap until you can get long-term financing set up. But understanding your options is crucial to know which financing strategy is right for your needs.
When Do You Need Short-Term Financing?
Short-term financing refers to sources of finance meant for a small period of time, usually less than a year. It's also called working capital financing. Typically, short-term finance is used to finance inventory, accounts receivables, and accounts payable — all working capital needs.
Often, this type of financing is for businesses with a short-term gap between cash inflow and cash outflow. If you ever need short-term financing, the first task is to identify why you need it.
Here are some of the usual reasons:
Covering a gap between collecting payments from customers vs. purchasing raw materials to start production.
Dealing with cash flow fluctuations.
Bridging the gap in the sales cycle.
Short-Term Financing Strategies
Now that you know why you need short-term financing, it’s time to find the right source of short-term financing for your social impact business. Each type has different characteristics and can be used for different situations. Here are the most common types of short-term finance.
Trade credit is the credit period extended by suppliers to a business. Suppliers typically give discounts when you pay within the given period. Otherwise, you might need to pay interest for payments made past the due date. You could say that the period before that would be free trade credit, and after that is paid trade credit.
But getting free trade credit entirely depends on how creditworthy you are and your discipline in payment commitments. In a cash flow crunch, you could consider extending the payment longer and paying extra interest. But you might want to watch out for its high-interest cost.
Business overdrafts are a financing option where a business makes payments out of its current account and exceeds its available balance. It virtually has the same concept as any other bank overdraft facility in your checking account.
If you overextend payment above the agreed limit, the interest gets charged to the extent the amount is used. So, depositing the amount immediately allows you to save on interest costs. It’s ideal for businesses with fluctuating financial requirements. Overdrafts could be provided either over a fixed period of time or as a rolling facility with no end date.
A revolving loan allows you to draw capital up to a predetermined credit limit. Here, you will only pay interest on drawn or outstanding funds. It's a flexible financing tool because of its repayment and reborrowing accommodations. You'll be able to either repay the loan or take it out again. An example of a revolving loan is an operating line of credit.
Invoice financing allows businesses needing short-term cash injections to get paid immediately. Thus, there's no need to wait days to collect customer payments. There are two forms of invoice financing: invoice factoring and invoice discounting.
With invoice discounting, the receivable invoices are discounted with banks, financial institutes, or a third party. Doing so means the bank would pay you the money at the time of discounting and then collect the money from your customer when the bill is due.
As for invoice factoring, businesses sell their accounts receivable to a third party which will factor at a lower rate than the net realizable value. It could be with or without recourse.
Purchase order funding helps companies with a purchase order on hand from a large client and need to pay their suppliers to fulfill orders. In this type of financing, you will receive a large purchase order from your buyer that lets you procure components from your manufacturers.
Inventory financing is a form of asset-based funding. Here, businesses turn to lenders so they can purchase the necessary materials to manufacture products that they intend to sell at a later date. Using this financing for a business allows its owners to leverage inventory, thus freeing up funds so the company can handle growing orders or pay ongoing business expenses.
Benefits of Short-Term Financing
Short-term financing is the perfect solution for small and medium-sized social impact businesses that need working capital quickly. Female founders tend to gravitate toward short-term financing for its speed and convenience. Some of the pros include:
Short application and funding process. Since short-term financing requires less supporting documentation, the application process is much faster.
Fewer fees over time. When you get a short-term loan, the goal is to have it repaid quickly. So you’re not spending more than you need to in fees.
Better approval rates. Alternative lenders tend to have higher approval rates than large, traditional banks. They are also more flexible with credit scores.
Mission-driven business owners will need solutions that fit the problem — if your issue is working capital, then short-term financing is the best option.
The Value of CFO Support
Understanding which financing option to choose can be challenging, especially if you're already handling the other aspects of your business. Even more critical: are you sure you need short-term financing solutions or are there other options available to you? A fractional CFO can help you.
A fractional CFO provides you with a wealth of strategic financial information and the know-how to apply it effectively. Having a fractional CFO on your team makes choosing the right financial decisions easier. Their support includes short-term financing, but their expertise goes beyond that into long-term financial strategy.
Investment in a fractional CFO's services can provide clarity regarding your next step and the journey after that. Schedule a call with Profit Reimagined™ and receive the benefits of CFO expertise today.