Many SME businesses get caught in a Cash Trap because they don’t understand how Working Capital functions.
No one has ever explained to them the many ways that Working Capital shortages can create a highly stressful Cash Gap in their business.
I explain the “how and why” of the Cash Trap in detail in a separate post. This article is about one simple, powerful strategy that’s fundamental to getting OUT of the Cash Trap.
There are three main Working Capital tools that I use to help my SME customers triumph over the Cash Flow pressures they face from unrecognised business Cash Gaps. These are:
- Invoice (Debtor) Finance
- Trade (Purchasing) Finance
- Unsecured Business Loans (Overdrafts)
This post explains Tool #3 – Unsecured Overdrafts . Other posts cover Invoice Finance and Trade Finance.
So here we go…
What is an unsecured overdraft?
An unsecured overdraft is a type of loan that is NOT backed by collateral, like a property or a car.
Instead, it’s based on the creditworthiness of the business.
Non-bank lenders typically offer these types of loans. Banks are less likely to offer these facilities to business. In today’s fast-growing world of SME non-bank financing solutions, there’s an increasing range of unsecured overdraft facilities available to small business operators.
Typically, a business owner would apply for the loan and – if approved – receive a credit line. The credit line is typically based on the business’s creditworthiness and its ability to repay the loan.
Once you have access to this credit line, you can draw on the funds as you need them – to cover your expenses during periods of low cash flow. You only pay interest on the amount you actually borrow (not the total approved).
Your business only pays interest on the amount of credit actually used (unlike other common bank loans such as term loans, where you pay interest on the loan total regardless of how much you actually spend).
An unsecured non-bank overdraft is a flexible option for businesses because it can be used as needed. You can draw on the credit line as you need to cover your expenses during a cash gap. If you don’t need cash, you’re only up for establishment and annual fees.
When is an overdraft REALLY unsecured?
If you have a business loan from a bank AND a personal loan with the same bank then – even if the loan is called “unsecured” – your home could still be in play.
Watch out for sneaky “all monies” clauses
Most bank business loans have an “all monies” clause – which means that the bank can call on ALL the assets that they hold mortgages over to meet your loan obligations.
Even if your business loan is documented as being “secured” by business assets (or your balance sheet) – if there is an “all monies” clause then you may have more on the line than you realise.
Why should every business have an Unsecured Overdraft?
The main reason for having an Unsecured Overdraft is increased flexibility.
Here are seven good reasons why the right Unsecured Overdraft facility can make your business better:
- Cover unexpected expenses: An overdraft facility grants your business instant access to cash when you need it most – and In uncertain times like these, having that immediate financial buffer can be a lifesaver.
- Get caught up on ATO obligations: As COVID recedes, authorities like the ATO are increasing their efforts to get overdue Tax Debt and other business operating costs (super and annual leave) paid. With a negotiated Payment Plan and an Unsecured Overdraft, this can be a manageable process, not a business breaker.
- Grab a new opportunity. A competitor goes under and puts their business on the market? A new job comes your way – one that needs new equipment, extra inventory or more people? An overdraft means you can take advantage of opportunity.
- Flexible Repayment Terms: Unlike traditional loans, an overdraft allows for more flexible repayments. You only pay interest on the amount you use, not the total credit limit. This can be a cost-effective solution when managing unexpected expenses.
- Build and Maintain Cash Flow: An overdraft helps you manage your available cash smoothly, ensuring that you can continue paying your suppliers and your employees even if customer payments are delayed. It’s a vital tool to keep operations running smoothly.
- No Need for External Collateral: An unsecured overdraft doesn’t require other assets as collateral. This means you can access funds without putting your family’s future at risk, thus providing your business with greater financial security.
- Strengthen Business Relationships: Paying on time – or even early – is a massive trust builder with suppliers. Having an overdraft facility enables you to demonstrate to your suppliers and partners that your business is financially stable. This trust can lead to better terms and win-win partnerships, enhancing your ability to navigate turbulent times.
An overdraft isn’t just a financial “product” – it’s a strategic tool that offers flexibility, liquidity, and security. In unpredictable times, these qualities can make all the difference in sustaining and growing your business.
There’s good debt – and there’s bad debt
Lots of business owners are scared of ALL debt – but there’s good debt and there’s bad debt.
Bad debt is debt that’s going to cost you money.
Good debt is debt that makes you money.
An Unsecured Overdraft can be either good debt or bad debt – it very much depends on how you use it:
- If you use it to extend the life of a loss-making business, or to paper over the cracks of poor business administration, then it’s bad debt.
- If you use it to increase your business flexibility and responsiveness, to leverage a new opportunity, or to save you money, then it’s good debt.
Costs of Unsecured Overdrafts
At time of writing, Unsecured Overdrafts are sitting at around 18%, depending on turnover. In monthly terms – and I look at business as a month-to-month cash flow process – that’s around 1.5% a month.
These aren’t large amounts – and they only apply for the period that you USE the overdraft funding.
If you don’t need money, you don’t pay interest.
Any business financing strategy needs to be matched to your business needs
Which business financing tools are best for your business? That depends on your business and its specific situation.
For many SMEs, unsecured overdrafts are part of a broader set of financing tools. They can be used in conjunction with debtor finance and trade finance – but they don’t have to be.
If your business doesn’t have the liquidity it needs to respond to unexpected opportunities or challenges, then an unsecured overdraft could increase your strategic capability.
If you’re seeking ways to grow your business, then book a strategy review with Cash Flow Strategist Martin Cattach today.
