Operating Term Loans
Revolving Lines of Credit
More Short Term Instruments
Approaching Short Term Debt Lenders
Term Debt Explained
Short term refers to the time for which a loan
is required and the period over which its repayment is
expected to take place. Short Term Loans usually take
the form of operating term loans (less than one year)
and revolving lines of credit. These finance the day-to-day
operations of the business, including wages of employees
and purchases of inventory and supplies. Supplies are
used up quickly and inventory is sold resulting in stock-turns
. Also bridge financing (interim loans with a short, fixed
term) can be used to finance accounts receivable contracts,
which are relatively risk-free, but delayed for one to
term operations money may be secured against first,
any unencumbered physical assets of the business; second,
additional funds from shareholders or personal guarantees
from principals. On occasion, inventories can be used
as temporary security for operations loans. Bridge financing
is normally secured by assignment of all the receivables
and personal guarantees. On the balance sheet the accounts
receivable, inventory and supplies stocks show up in
the current assets section, while the counterpart loan
information is displayed in the current liabilities
normally charge a higher base rate of interest for operating
loans reflecting this relatively weaker security position.
The amount of the operating line of credit, will be
determined from the projected cash flow information
in the business plan. Lenders favour businesses that
exhibit strong management, steady growth potential and
reliable projected cash flow (demonstrating the business'
ability to pay the monthly interest payments on this
line of credit from its projected revenues in a written
Operating Term Loans
Operating Term Loans for working capital are
used to enable a retail, service or manufacturing business
to purchase raw materials, retail or parts inventories,
process or promote these and pay monthly expenses including
principal and interest on outstanding term loans, wages
and salaries, rentals, leases, utilities, etc.
a business was able to sell all its inventory (stock)
at full margin and collect the cash for it immediately,
realizing its profit before it had to pay suppliers
for that stock and before it had to pay its monthly
expenses, that business might require no particular
working capital loans. However, most are not cash businesses
and don't enjoy that luxury. They face build-ups of
day-to-day and monthly expenses such as stock parables,
wages, rentals, leases, etc., often in advance of collecting
the cash sales revenues to pay the trade suppliers,
the labour commitments and the regular overhead expenses.
Operating Term Loans (Working Capital) are commonly
offered by credit unions and non-commercial lenders
who are unwilling or unable to offer operating (revolving)
lines of credit to their customers. This term loan is
made like any other term loan, and is fully secured
against unencumbered assets, personal guarantees and
Revolving Lines of Credit
A line of credit is a long term commitment
by a commercial lender to honour the day to day cheques
of a business up to a maximum figure agreed to in consultation
with the business. The lender retains a number of signed
drafts (notes held for discount) from the business on
hand to use as required to place funds as needed into
the account. The business was made responsible for depositing
all sales revenues on a regular basis into the account
to "buy down" the outstanding loan balance
whenever there were the funds available to do so.
up and down, fluctuating nature of the loan amount (account
balance) is why it has come to be called a "revolving
line of credit." There is no scheduled repayment
of principal because there is no set principal amount
of the loan. The interest rate normally floats at 2%-3%
above the prime rate and is applied to the largest amount
of loan outstanding in that account during the course
of any month. There are no other account service fees.
revolving lines of credit are the preferred borrowing
formats of most commercial businesses and manufacturers.
The normal sources of these loans are commercial lenders,
the chartered banks, and more recently, some credit
unions. Most commercial businesses require differing
amounts of cash each month to meet their actual operating
commitments for that month; they want to pay only interest
justified by the actual usage of borrowed cash (without
penalties); and pay nothing at all when revenues are
entirely sufficient to pay the month's expenses. This
requires a special kind of loan that can provide long-range
flexibility (allowing the principal of the loan to vary
from month to month); that can temporarily cancel the
loan without penalty in a month where borrowing is not
required; and that can provide an almost automatic approval
from the lender for each new loan amount (to a maximum
overdraft). While some of this might be achieved by
a Bank Overdraft Scheme, the more commonly accepted
way is to use a revolving line of credit.
More Short Term Instruments
More recently the banks have fine-tuned this
program to what could be called a planned overdraft
scheme . The bank will approve a business for a certain
overdraft amount. They no longer work with a series
of pre-signed drafts. The actual interest rate has been
dropped to a point to two points above the prime rate
and a system of service charges for the overdrafts has
been substituted to make up the difference.
Interim loans are a type of bridge financing
intended to "bridge the gap" between the time
a specific receivable is received in cash and the time
the company's parables become due. The assignment of
the receivables is the primary security for the loan.
This is quite common where a government agency purchase
has been made. The lender knows the customer will pay,
but also that the cash may take some time to collect.
When a government financial assistance program makes
an award, reimbursable only after the moneys have been
spent or the project is in place, bridge financing is
an appropriate format.
of Book Debts (Receivables)
The receivables are assigned to the lender
to secure the operating line of credit. These are still
collected by the business, but in the event of business
default, the lender can assume collection of these directly.
The assignment is supported by the monthly submission
of the list of receivables.
under Section 88
Section 88 of the Bank Act allows a business
to use goods-in-process, future crops, livestock, etc.,
as security. Possession and title are retained but the
lender has certain rights with respect to the sale of
the finished products.
for Working Capital Loans
The lender uses accounts receivable (the money
owed by customers) and inventory as the security (collateral)
for the loan. For accounts receivable lenders may lend
between 50% and 75% of the total outstanding receivable,
first deducting any invoices which have gone over 90
days. On inventory, lenders may lend up to 50% against
cost based on supplier invoices. Any additional cash
required must come from your own resources or by careful
management and recirculation of the business' profits
The principal makes an agreement that if the
limited company is unable to repay the loan, he/she
will do so personally. If this guarantee is on top of
other security, attempt to negotiate a limited guarantee
to cover only the shortfall in the security. Recover
the personal guarantee as soon as the business has paid
off its obligation or can carry the debt on its own
security. A personal guarantee places all those things
you and your family hold dear at risk.
If there are also loans from shareholders,
the lender may ask for an agreement that the company
will not repay the shareholders until the secured lenders
have been repaid in full.
Approaching Short Term Debt Lenders
The institutional providers of first level
mortgage lending include the Insurance Companies, the
Banks, the Trust Companies and the Pension Funds. There
are also many short term loan financiers to be found
in the private sector. Many of these advertise their
services aggressively, especially where their offerings
relate to mortgage extensions on property in stable
real estate markets (such as the Lower Mainland market).
can be easily located through licensed and bonded consultants
known as mortgage brokers. These offerings normally
involve terms of one year or less with liberal provisions
for renewal. For these reasons these mortgages often
charge only interest, but have hefty penalties for returned
cheques and late payments.
first mortgage will earn the lender approximately 12%
interest, a second mortgage, 15%, and a third mortgage,
18% - 20%. Many of these will have, in turn, leveraged
and sourced two thirds of their funds for this mortgage
from an institutional or commercial lender, and accordingly
they will have to comply with various restrictions placed
on their investments by that lender.
mortgage financiers would normally be approached after
you have exhausted the commercial channels and been
rejected from dealing directly with them due to some
weakness in your equity or personal guarantee abilities.
There are many short term mortgage loan financiers
to be found in the private sector. Many of these private
mortgage financiers advertise their services aggressively,
especially where those offerings relate to mortgage
extensions on property in strong real estate markets
(such as the Lower Mainland market).
Banks and Credit Unions:
The Commercial Banks and Credit Unions are
normally prepared to offer financing based on accounts
receivable bridging and/or inventory purchases. Revolving
or operating lines of credit (and overdraft schemes)
are offered by the major commercial banks and some credit
Commercial Banks/Credit Unions:
Loan evaluation tends to be more rigorous and
sophisticated than mortgage loan evaluation. In summary,
this lender is evaluating the immediate abilities of
the management team, the collateral available to support
the loan and the short term commercial viability of
the situation, as portrayed in the projected cash flow
financial submissions. This cash flow projection will
normally be included in a detailed business plan (in
a bound presentation format) providing extensive information
on the management of the company or project; a detailed
history of the business, its current products, its production
methods, its operations, its position in the marketplace;
the purpose for which the loan is intended (in intimate
detail); any security available to be pledged; and extensive
financial information and projections.
to prepare this presentation can be accessed through
the Management Services arm of the Business Development
Bank of Canada or the Start-Up Centre of the Canada/British
Columbia Business Services Society.
Creditors, Factors and Commercial Finance Companies:
Trade Creditors offer terms of 30 days before payment
for stock purchases is due. With newer, unproven operations,
C.O.D. (Cash On Delivery) is often required. Occasionally,
in a buyers' market, an important large dealer will
be offered 60 day payment terms. Often a 2% discount
will be offered to dealers who pay within 10 working
days and a penalty (e.g. 1.5% per month interest) will
be imposed on account balances unpaid after 30 days.
Companies may buy accounts receivable outright without
recourse and assume all the risks of collection. These
may advance funds against purchased receivables, less
Finance Companies often advance funds upon assignment
of receivables and warehouse shipping/receiving receipts.
They will also consider short term equipment financing.
Trade Creditors, Factors and Commercial Finance Companies:
Sales finance companies, in cooperation with the product
suppliers (vendors) commonly offer sales finance or
factoring programs and lease-back options on their equipment.
The onus is upon you to ask your vendor if he/she has
access to any such finance programs, or if the vendor
will finance the purchase directly, through a factor
or floor-planner scheme. Small office equipment may
often be purchased on a lease-to-buy arrangement. Generally,
these will expect a less detailed business plan, but
will be particularly interested in the parts that relate
to sales projections, stock movement and replenishment
and monthly cash flow information.