How short-term financing works for small businesses

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Finding short-term financing options to support your company's growth is typically time-consuming and complex. Which is a shame, because there are actually many good options for financing working capital requirements. And they don’t all require months of delays and piles of paperwork to get started. 

In fact, the real dilemma should be choosing between them all. 

To help you in this task, this article gives you five of the most interesting short-term funding options for SMBs. What are their specific features and benefits for your business? How can you create the right financing mix for your business? You'll find the answers to all your questions below. 

But first, a quick reminder...

What is short-term financing?

Short-term financing helps you fund your immediate working capital requirements. These financing agreements generally extend over a period of less than a year. Its purpose is to help the organisation generate the cash it needs to run smoothly.

Because it is mobilised quickly and used over a shorter period, short-term financing is usually for smaller sums than traditional financing. It tends to be non-dilutive (more on this shortly), using items like your receivables or future revenue as collateral.

The advantage of short-term financing is that it responds to a problem faced by the vast majority of companies — particularly SMBs: the unpredictable nature of cash flow, particularly due to the seasonal nature of these businesses. But it can also occur for more fortunate reasons — in particular, the financing of new projects or rapid growth.

Why use short-term financing?

There's no clear road to business success. Every business has its ups and downs. But founders don't always know or understand how to use short-term financing when the going gets tough. Even though it’s often exactly what you need.

When business falls off, it may be necessary to look for new sources of finance to make up for a lack of cash. Your business depends on its working capital to keep it going during a lull — in the low season, for example, or a general economic downturn. 

An injection of capital gives you the boost you need to prepare for the high season (or recovery). Or to accelerate your growth, develop new products, or position yourself in a new market. Short-term financing can also, more simply, be used to cover your day-to-day operating expenses if necessary.

Every organisation is likely to encounter situations requiring the release of short-term finance. Here, however, are the main situations in which such assistance may be useful!

Fill a gap between the main financing cycles

Start-ups, SMBs, and growth companies generally rely on short- and medium-term financing to develop rapidly and acquire new market share. This is particularly true during the first few years of their existence. In general, at this stage, they’re not yet established or mature enough to generate sufficient revenue for marketing campaigns, R&D, or to set up a distribution network. 

Short-term financing can therefore bridge the gap between the various fundraising phases. Short-term cash flow will compensate for the need for financing. At least until the company is mature enough to finance itself and operate at full capacity.

Preserve your precious equity

Equity financing involves giving up a real stake in your company. In doing so, you give up some of the governance over your business, in exchange for capital from investors. This type of financing is best reserved for major investments and “levelling-up” your business. But not to cover day-to-day operations or to get you through a slow period. 

Equity financing is almost always more expensive in the long term than debt funding. Short-term credit helps you avoid diluting your shares in the company and maintain control.

Take advantage of good opportunities

You’ve no doubt at some point had to let a great commercial or partnership opportunity slip through your fingers for lack of the necessary funds. Short-term funding is a good way of freeing up cash quickly so that you can deal with unforeseen circumstances and emergencies, but also seize opportunities when they arise.

A business opportunity may let you buy new stock at a limited-time-only price. Even if your relationships with suppliers are excellent, they won’t hold a great deal forever. So you need to release funds quickly. A short-term loan lets you overcome this situation and get started at the right time!

Manage cash flow problems

Once again, every business is likely to have cash flow problems at some point. A lack of working capital is the number one cause of small business bankruptcy.

One key issue is the cash conversion cycle: you need money before your customers are due to pay. This situation can quickly become uncomfortable if you don't have enough cash to cover your operating expenses. 

Short-term financing is the ideal solution for keeping your business afloat until you receive the payments you are owed.

Many organisations also struggle to find the right balance between fluctuating demand and limited resources. Here again, short-term financing helps to bridge a more seasonal cash flow gap. In sectors of activity that are particularly affected by seasonality — tourism or events, for example — short-term credit is even more necessary to ensure that your business lasts over time. 

4 short-term funding options for small businesses

Whether you need short-term finance to meet your obligations, fund a new project, or enable your business to grow, it's important to be able to turn to the financial mechanism best suited to your organisation and its needs. 

Here are some of the ways in which you can finance your working capital requirements. How you raise these funds depends on the needs of your business. But they’re certainly all worth exploring. 

1. Factoring

Factoring is a short-term financing option for businesses involving a third party. The idea is simple: the creditor company transfers its trade receivables to a factor. In exchange, the factor provides immediate financing for part of the total amount owed. The factor then directly manages the collection of payments from customers. 

Prepayment of the invoice is generally made for 80-90% of the sum due. This is a good way of managing cash flow problems, particularly for organisations with a credit rating too low to turn to their bank. At the same time, it can be slow to get started and the terms aren’t always as flexible or favourable as you might like. 

For more, here’s an explanation of the advantages and disadvantages of factoring.

2. Invoice discounting

Sometimes known as "Dailly," invoice financing or discounting lets you receive payment in advance for your receivables. That’s obviously similar to factoring, but with a few clear differences. 

First, the invoices remain in your hands. Once the customer pays, you pay back the bank. Which means you’re also responsible for collections, unlike in a factoring arrangement.

For the bank to accept this transaction, they usually want to know that your customers are solvent and that the invoices have a high likelihood of being repaid. Which can make an invoice financing agreement harder to attain, with lots of added due diligence. But if you’re highly confident that customers will pay and you just need a cash injection, this is a valid option.  

3. Accounts payable financing (or supplier financing)

The other side of the cash conversion coin, accounts payable financing lets you obtain funding against your unpaid supplier invoices. A financing partner gives you the cash you need upfront to buy stock or invest in a specific strategy, in exchange for a future fee.

This is another way to take advantage of attractive offers and supplier discounts, even if you don’t have the cash available. It’s even possible to save money in the process, if the discount received is higher than the fee paid to the financing partner. 

Whatever the reason, this financing option again gives you cash immediately to move quickly and stimulate growth, even where receipts are low or slow. 

4. Revenue-based financing

Revenue-based financing (or RBF) is often used by SMBs that would not otherwise be able to obtain more traditional forms of capital. 

In practical terms, this type of financing involves opening a line of credit with an investor, which will be repaid via a percentage of the future income generated by the company's anticipated activity. Unlike a traditional loan, where the company repays a fixed amount with interest, RBF refers to regular payments based on the company's (fluctuating) income. This usually continues until a predetermined multiple of the amount initially invested is reached. 

To obtain this funding, you normally need to show a clear path to revenue — essentially a sound business plan. 

Choose a short-term financing plan to meet your objectives

Companies that can deploy their working capital when they need it most can remain agile, and are best placed to grow in a competitive environment. 

But to achieve this, you need a few essential ingredients:

• A clear view of your current working capital position
• An understanding of the right timing to launch or grow your business 
• Access to the best short-term financing option

The latter must be aligned with your needs, while providing you with a minimum of effort and red tape.

This is where Defacto can help. Whether you need payables or accounts receivable financing, our ACPR-approved B2B lending platform gives you access to funds faster (and often, cheaper) than any other option! 

To find out more about our financing options and terms, visit Defacto.