By Prof. E. Ofori Asamoah
Certified Management Consultant and President, Regent university College of Science and Technology
The need for alternative ways of financing small and medium enterprises (SMEs) could not be over emphasized. We have discussed asset-based financing which we covered Asset-Based Lending and Factoring.
Just like factoring, invoice discounting is a form of short-term borrowing where a business pledges its account receivables (typically 80% of invoices less than 90 days old) to a third party as collateral for cash to enhance its present cash flow (Milenkovic-Kerkovic & Dencic-Mihajlov, 2012). After collecting its debts, the firm then pays back the finance company the amount borrowed plus interest charge which is normally a percentage of the account receivables. Invoice discounting is almost the same as factoring except that in this arrangement, the business retains control of its own sales ledger and pursues its customers for payment without the third party been known to the customers. Thus, the key difference between invoice discounting and factoring lies in who takes control of the sales ledger and the responsibility for collecting payment from customers.
Leasing is a form of financial agreement whereby one party conveys to another party the right to use an asset for an agreed period of time in return for specified rental payment while retaining the legal ownership of the asset. In a typical lease arrangement, the lessor (owner) transfers the right to use a property to a lessee (user) in exchange for rental payment for a specified period after which the lessee can do three things:
Buy the property outright,
Return the property to the original owner,
Extend the leasing period.
There are two types of lease agreements – operational lease and finance lease.
In an operational lease, the lessor supplies the property or equipment to the lessee; the lessor is responsible for servicing and maintenance of the leased equipment; and the period for the lease is fairly short, normally less than the economic life of the asset so that at the end of the lease period, the lessor can either lease the asset to the same person or someone else and obtain a good rent for it; or sell the equipment. In an operating lease, the lessor (often a finance house) purchases the asset from the manufacturer and then leases it to the user (lessee) for the agreed period. On the other hand, a finance lease is an agreement between a finance house (lessor) and a lessee where a finance house agrees to act as a lessor in a leasing agreement and purchases the asset from the dealer and intends to lease it to the lessee. Here,lessee takes possession of the asset from the seller and makes regular payments to the finance house under the terms of the lease.
4. Hire Purchase
Another alternative form of asset-based finance is hire purchase. Under a hire purchase form of financing, the business agrees to make payments in installment for a non-current asset over a period of time within which the legal ownership of the assets still resides with the seller until the final installment is paid for the asset to be legally transferred to the buyer .
Thus, under a hire purchase agreement, the business or buyer possesses the asset after the initial installment payments while the legal ownership of the asset remains with the supplier/finance house until the last installment payment is made.
5. Alternative Debt Instruments
Alternative debt instruments comprise an external financing option that grants businesses access to credit from the capital market through the issuance of various forms of bonds. Examples of alternative debt financing instruments include corporate bonds, covered bonds, securitized debt, and private placement. The difference between alternative debt and bank credit or other traditional forms of debt is that alternative debt instruments are issued in the capital market while bank credit is issued by banks and other financial institutions. In a report of OECD (2018) on alternative financing options for SMEs, it was revealed that despite the various forms of alternative debt instruments available to SMEs, it appears that SMEs do not utilize these financing options and tend to rely on traditional sources of finance.