What is Contraceptive Business Finance?
Put simply it is about cash reserves and the cash you call upon when things don’t go quite to plan, meaning that the impact is lessened and the business continues. The term ‘contraceptive’ is used as this is about finance used as a tool of prevention.
A YouGov survey conducted for Simply Business reported that of all the businesses that didn’t apply for finance in 2014, 85% said the reason they didn’t apply was that they had no need.
All pretty simple.
Until the unexpected happens.
Balance that 85% of businesses won’t raise finance because they don’t need to against the statistic that 52% of businesses have less than £10,000 in reserves.
Of this 52%;
- 3 in 10 SMEs have £500 or less
- 20% have no reserves at all
- 16% of businesses do not know how much cash they have in reserve
This means that there is a lethargy among companies to seek finance, whilst also living with very limited resources. This works fine when things are going to plan, when times get a little more difficult the SME suddenly comes under real cash pressure.
Raising finance at a time when it is urgently needed is both more difficult and more expensive.
This is where contraceptive business finance comes into play.
There is a simple theory when underwriting credit that the proposal the lender wants is one where the borrower doesn’t need to borrow. The greater the need for finance, the less the lender wants to lend.
In reality there is normally a way to raise finance regardless of the story, it’s just that the options become narrower and the cost becomes higher.
The contraceptive finance model is about borrowing when times are good to provide a buffer (or cash reserve) for when trading becomes harder. The better the cashflow forecast the business has the easier it is to plan for these periods.
Raising finance does not need to be for any specific purpose, moreover it is about recognising that it is easier to raise finance when times are good rather than wait until you need it.
The Corporation Tax Scenario
A client recently came to us needing to pay corporation tax. The tax fell due the same time as payroll. The need for funding came about due to some poor forward planning. The positive was that a corporation tax bill meant profits had been made. Because funds were needed quickly and because of the purpose the cost of the finance raised was higher than it needed to be.
Had the client recognised that a risk of tax and payroll coinciding existed, and the payment of tax been planned for better then the company could have borrowed in advance (on cheaper and on better terms).
In this case the contraceptive model would have worked. It would have provided the cash reserve needed to overcome this period.
Recognising that a cash reserve is something a business should have, and that raising finance doesn’t have to be done solely when needed are key to many businesses.
Borrowing doesn’t have to be spent on drawdown, it can be used to buffer against a downturn or period of cash flow pressure.
The contraceptive business finance model is one that many companies would do well to consider.
By Dave Farmer
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