Defining a business’ financial requirements and the most suitable banking solutions (illustration with a balance sheet)
Who is concerned
Bank financing concerns any business set up in the form of a sole proprietorship or company that wishes to develop its commercial activity via:
- the creation of a business;
- capital investment (acquisition of machinery or equipment);
- international expansion;
- cash flow requirements (payment of suppliers, balancing unpaid invoices by clients);
- internal growth (development of activities, creation of subsidiaries);
- external growth (merger or takeover of another business).
The type of guarantee and the guarantee requirements vary depending on the type of bank financing sought and the risks involved. Receiving a guarantee enables the bank to ensure that there will be no problems with the financing and that it will be fully repaid. The bank first looks at the client’s solvency as well as the profitability of the project to be financed. Beyond this, the bank may request one or more of the following guarantees:
- a mortgage;
- a pledge;
- a surety;
- a moral commitment;
- contribution of capital;
- an insurance policy.
Balance sheet structure
The new 'Basel II' regulations include all of the requirements in terms of own capital in order to provide security in respect of credit. Among a whole range of financial criteria and indicators, the business must have a good rating with the bank and other creditors. Before starting a project requiring significant funding, it is therefore advisable to examine the balance sheet structure and ensure its optimisation.
The structure of a balance sheet perfectly illustrates the financial requirements, the suitable financial solutions and the guarantees required by banks to cover the risk. This table shows the business' financial situation as well as its requirements:
ASSETS (uses of funds)
LIABILITIES (sources of funds)
As a general rule, the balance sheet is organised chronologically from top to bottom, i.e. from the long-term to the short-term. This applies to both assets and liabilities. Long-term uses of funds have to be financed by long-term sources of funds. Long-term sources must exceed the long-term uses, thereby enabling the financing of part of the short-term uses to ensure that the business has a certain degree of liquidity.
The assets represent the company’s requirements on the one hand and its investments on the other:
- long-term items are those that are the least realisable; they are grouped together under the term 'fixed assets';
- short-term items (the most realisable) are called 'current assets'.
The word realisable means the ability to dispose of the items and convert them into liquid assets (cash), with a view to investing them elsewhere.
The liabilities represent the different sources of funds available to the company for financing the investments necessary for the smooth running of the business:
- long-term items are funds which are 'permanently' available to the company (long-term capital);
- short-term items consist of funds that are made available to the company on a temporary basis.
How to proceed
Financing intangible fixed assets and capital assets
A subordinated loan (junior debt) is generally used to finance intangible fixed assets and capital assets. This is particularly the case for the takeover of a business or the purchase of a business, patents or licences. On the liabilities side of the balance sheet, this type of credit is situated between owned capital and long-term loans in terms of risk. A subordinated loan can be in the form of a mezzanine loan, a debenture loan or even a convertible debenture loan (convertible into shares).
Financing investment projects
A business’ investment projects are often of a long-term nature and are generally financed over the medium or long-term. They can involve movable assets (production tools, machinery, vehicles) or property (land, industrial buildings, offices) intended for the creation, improvement or development of the business activity. The entrepreneur can choose between various banking solutions in order to finance investments, namely:
- a long-term investment loan for movable assets or property;
- a bullet loan: the loan is repaid in one instalment at maturity;
- a bridging loan: to finance a cash deficit;
- a syndicated loan: used to finance large-scale projects;
- property leasing: acquisition of a property in exchange for rental payments.
Financing everyday investment projects
Everyday investments involve, above all, the acquisition and renewal of smaller-scale equipment and the vehicle fleet and are generally carried out through short and medium-term financing, namely:
- capital leasing: leasing with full rights and the option to subsequently acquire ownership;
- operating leasing: leasing for a shorter period and possibility of subsequent purchase;
- medium-term loan: 1-5 year bank loan;
- roll-over credit: loan with a variable interest rate fixed for each partial period.
The financing of the operating cycle, working capital needs and cash flow requirements affects, in particular, stocks, receivables and cash flow. There are various ways to finance growth, namely:
- a cash credit: temporary current account overdraft;
- fixed advances: temporary provision of a certain amount for a clearly specified period;
- invoice advances: advances paid by the bank against a pledge on receivables;
- discount credit: payment of the amount of a commercial paper by the bank in return for fees;
- factoring: assigning receivables to the bank.