24 Oct Business Financing Terms For Dummies
Business Financing Terms That Won’t Confuse You
ACH funding is an electronic funds-transfer system that is run by the National Automated Clearing House Association (ACH). The use of this electronic transfer increases the efficiency and timeliness of government and business financing transactions.
Collateral is a way for the borrower to assure the lender that he or she will repay their loan. If the borrower defaults on their loan, the lender would have the legal right to the collateral in order to pay off the loan. Most banks require borrowers to put up some collateral before they will lend, however now there are several options for non-collateralized loans.
Investopedia.com defines bad paper as “An unsecured, short-term fixed income instrument that is issued either by a corporation, city, state, or country.” For the most part, bad paper is not backed by collateral, therefore, it is a very high risk to the lender. Bad paper has a high chance of default and often times, the institution that lends the bad paper, also has a high risk of default. The high default risk of bad paper gives way to very high interest rates, in order to compensate for the high risk.
The book value of a company according to its financial documents. This can be easily calculated by subtracting liabilities from assets. This figure can also be call the a company’s value or net worth.
Typically the borrowing base refers to the amount of money the lender will loan to a company. This number is based on the amount of collateral the business is willing to put up in order to get the loan. The more collateral, the bigger the loan amount. The borrowing base is a number, so how is it determined? Usually borrowing bases are determined based on the risk the lender believes the borrower to be. Based on that risk, a discount factor is determined. Say for example, based on company X’s risks, they are able to get a discount factor of 75%. If the company is offering $100,000 in collateral, then they will be able to borrow $75,000. ($100,000 x 75%).
This term refers to the movement of cash into or out of an account. Loans based on cash flow like ours, do not require collateral and thus, a business must show positive cash flow to qualify. Cash flow is used to define the health of a company and gauge their financial performance–it is like the blood of the business. Before entering into an agreement with a company, investors and lenders alike look for a positive cash flow in a business. If a business wants to survive and thrive, it must have positive cash flows. A positive cash flow can come from several activities: financing, operations, or investing.
A reservation that is placed on collateral even when the collateral changes. A good example of this is when a bank places a floating lien on a company’s inventory. It is known that over time, the inventory will fluctuate, going up and down. When the company places this kind of a lien, it usually means they have an interest in the set of company assets when the lien is placed. If the company goes into default, the value of the floating lien becomes a fixed charge, which gives the lender priority as a creditor.
Factoring is when a third party intermediary purchases a company’s accounts receivables. The factor (the party who is purchasing the invoices) will usually give the company a certain amount of money, which is less than the actual amount the receivables are worth. Factoring is usually an expensive form of financing because the factor company takes their cut and also needs to account for those who may not repay their invoices with the original company. However, it can be useful industries where it takes a long time to convert cash to receivables and for companies who need cash to take advantage of additional business opportunities.
Buying with borrowed money is first and foremost, risky. First, margin is a loan that is given by brokers to investors and traders who use the borrowed money to purchase stock. Usually a broker requires collateral from whoever is borrowing money. Investors use margin to increase their purchasing power. For example, say you want to buy $200 worth of stock, you invest $100 yourself and get another $100 from a broker. Then, when your stocks increase, say 25%, you increase your profit by $50 ($200 x.25%). Meaning, you pay back the broker $100, you put in $100, and made a profit of $50. You doubled your money.
The value of a company which is determined by the stock market. According to Investopedia.com, this is calculated by multiplying a company’s outstanding shares by it’s current market price. If a company has $2 million shares and each share is worth $40, then the company’s market value is $80 million. When investors, analysts, and media talk about the value of a business, they are likely referring to the this figure, the market value.
Origination fees are usually a part of any loan service. This fee is put in place by the lender to cover the costs associated with processing and securing the loan, in other words, commission. The fee is usually a percentage of the total amount of the loan. Generally, origination fees are about 0.5% and 1% of the loan.
The pre-approval process includes the evaluation of a potential borrower by a lender. This process determines whether or not the borrower qualifies for a loan through the lender, or the maximum amount that a lender would be potentially willing to lend. If after a decision has been made and if the borrow has been pre-approved and would like to move forward, they will proceed to submit additional documentation. *Note: If something happens between pre-approval and approval status, the lender has the right to deny funding to the borrower.
Syndicated loans are loans that are given by a group of lenders (or a syndicate) who all contribute funds to a single borrower. The borrower can be a corporation, a large project or a sovereignty (such as the government). (Investopedia.com), 2013. During these loan arrangements, there is usually one party who is the lead banker or underwriter. They can also be referred to as the “arranger” or “agent”. This lender has a bit more authority than the other “syndicates”. This means, they are responsible for performing duties such as administrative tasks and distribution cash flows among the other members of the syndicate.
According to Wikipedia, the main goal of a syndicated loan is to spread the risk of the borrower default across multiple lenders. Syndicated loans tend to be much larger than standard bank loans and because of that, the risk of one borrower defaulting could cripple a single lender. (Investopedia, 2013).
An underwriter can be a company, a person, or an entity that works closely with the borrower to secure a loan. They determine the price, announce the interest rate, and work with the client during the entire loan process. Most of the time, they earn profits from an underwriting fee.
* Information derived from Wikipedia.com and Investopedia.com