Financing Agreement Between a Business and Its Bank - Case Study Example

SUITABLE INNOVATIVE FINANCING OPTION FOR DALMA IT

Since the directors are extremely price-sensitive and do not want to borrow more than what is necessary because it will make them incur more costs, DALMA IT Software Consultancy and Solutions can acquire the required funds through an overdraft facility from the banking institutions depending with their credibility. An overdraft refers to financing agreement between a business and its bank where a company is instructed to put the bank operating account into a deficit up to a certain limit agreed upon. The overdraft facility terms such as unused limit fee, overdraft amount, other fees, and interest rate are usually negotiated with the bank. By using an overdraft facility, DALMA IT Software Consultancy and Solutions will be able to achieve the cash flow timing. Therefore, an overdraft behaves in a periodically fluctuating manner. It is normally positioned in deficit when expenses have been settled and placed in credit when revenue is credited. Overdraft facility tends to have low-interest rates; thus, the company will incur low-interest rates. The facility also provides an opportunity to withdraw the money from the bank over a regular interval of time without the need to pay extreme interests. This facility will work best for the company because it will be able to fulfill its financial needs regularly, thus not withdrawing excess money from the bank; therefore, the directors' need to use funds sensitively will be achieved (Leopoldo & Jose 2).

APPLICATION OF OVERDRAFT POLICY TO DALMA’S IT MATURITY PHASE

In the early stage of its development, DALMA IT Software Company considered adapting its business model to the ability to generate value for stakeholders by dynamically searching for the best consideration of the business model. Also, the company is usually not reliant on strong partnerships with a great number of stakeholders (Adam and Marek 1). According to the case study, the company entered into three or more-year contracts with a few firms and has experienced a 120% year-on-year growth since 2015. However, it seeks to enter into a few more deals to expand its operations, and that is why it is aiming for more funds. In this early stage, the company was formed based on its ability to react to any signals that forecast change in its internal and external environment. If managers were not cautious enough to create a business model that accommodates a difference in its operations, then the business would have probably experienced losses that would have led to its collapse. A business change can occur either naturally or forced, depending on the state of business (Adam and Marek 9). For DALMA IT Software Company, the change seems to have happened naturally because slowly by slowly; the company started experiencing pressure on their cash flow as it aimed to deliver their growth. This pressure acted as an indicator to show that the business is growing, and it is now time for it to increase its working capital so that it can tap more growth opportunities. The company's current working capital is not sufficient, and it is now high time for the business to upgrade to maturity level.

A company like DALMA IT Software Consultancy and Solutions has a profitable business model and aims to achieve a higher market capitalization in its maturity stage. At its early development stage, it is already attractive to stakeholders and investors and even has more top market opportunities, thus strengthening its value (Adam & Marek 8). This report is according to the case study, which states that the overall business had a very compelling growth story and trajectory, which made finding interested lenders a walk/run in the park. The intercultural exchange of companies and strategic behavior stimulated the formation of new platforms and sources for developing competitive advantage and also a strong and stable source for creating long term value. This new management concept is known as sustainability. Sustainable Development adheres to the principles of economy, ethics, and ecology, meaning that a company can manage flexibly and quickly, pay attention to objectives and promote the implementation of the company's vision and mission, and be accountable for creating a competitive advantage on the market.

Competitive advantage can be achieved by inventing new products and services and executing modern management concepts and methods. As a result, sustainable business can be referred to as a business operated when concepts of corporate social responsibility and value-based management are used in a systematic manner offering value for company investors (Adam & Marek 9). The application of sustainable business at all management levels, which comprises all the functions and factors therein, guarantees business continuity and the power of value creation in the long term. It also ensures a dividend payout to shareholders that is sustainable and the creation of a social dividend to other stakeholders of DALMA IT software company. The combination of these functions and factors will lead to the search for the ideal business solutions. This sustainable business can be executed through the mutual, constructive evaluation of factors and resources impacting the ability to intensify the value of a company. The most significant factor is finding a balance that will guarantee the company's continuity in the market while accomplishing business results, which ensures the company's long-term value. The balance that provides the implementation of the sustainable business concept may be a result of developing a viable and sustainable business model that connects with the Value-Based Management principles, corporate social responsibility, and the concepts of sustainable business and investors (Adam & Marek 10).

The use of an overdraft facility in this maturity phase will help DALMA IT software company achieve its sustainability. One of the main positive effects that the overdraft facility will have on the company is, giving it access to extra funds to suffice the working capital. This makes an overdraft facility a perfect financial backup for emergency costs, temporary financial issues, and unexpected expenses. Other positive effects of an overdraft facility include; it is quick to arrange because it does not require directors to travel or wait for a specific period to receive the funds. It is flexible in that a business can only borrow the exact amount of money it needs at a particular time, thus making it cheaper than a loan. It acts as a safety net because once the company withdraws the amount of funds it requires, it will only pay interest on the amount of money that was withdrawn only; thus, it acts as a low-cost safety net. It also has flexible time limits, and the company can agree with the bank the amount of time that it needs the overdraft to be available (MOZO). The company can also close the overdraft facility at any time it feels, although after paying the outstanding balance. Another positive effect is the choice of security. The bank, which is the lender, provides both secured and unsecured business overdrafts. The company has the freedom to select the type of overdraft it requires lastly;, no interest is incurred if the overdraft is paid earlier than expected.

The main negative effect of an overdraft facility is, the amount of funds that DALMA IT software company can access through an overdraft facility is usually lower than that of a loan. The interest rate also tends to be higher than that of a business loan because once a withdrawal has been made from an overdraft facility by a company, the interest rate charged is usually based on a daily rate which makes it higher than a business loan interest rate which is generally charged on an annual or semi-annual basis. The second negative effect is that it attracts fees. Other than an interest rate, an overdraft facility attracts fees even if no amount is withdrawn from it. These fees could consist of; late payment fees, application fees, and annual fees, usually charged as a percentage of the total amount limit or dollar figure. The last negative effect is that it can be quickly terminated by the bank at any time, just like how the company can call off the business overdraft at any moment (MOZO).

PRIMARY AND SECONDARY IMPACTS OF OVERDRAFT FACILITY TO THE VENTURE AND THE OWNERS

The primary impact of an overdraft facility on the venture is that it acts as a fast and secure financial backup when an emergency need arises. Some of the company's clients may delay paying the company; therefore, DALMA IT software company may use an overdraft facility to settle its expenses such as employees' salaries and suffice its working capital. An overdraft facility can also affect the DALMA IT software company's creditworthiness because most overdrafts are usually reported on the Credit Report of the company as an account that has a limit. Other lenders typically view this as potential debt, even when it is not in use. A primary impact of the facility on the owners happens when the bank demands payment of the overdraft immediately (Andrew). Such a case may force the owners to enter into their pockets and pay the overdraft if the company does not have the funds to do so, resulting in a loss to the owners. However, this depends on how the company is structured. Besides, if the company and owners are not in a position to settle the overdraft facility, it also leads to legal proceedings against the company, a rise in the current and future interest rates that will be charged, and even collateral seized if the company had provided it.

A secondary impact of overdraft facility to the venture is that it can deter the company from getting credit in the future if it is not well managed, that is, if the company does not pay the overdraft in time or withdraws an amount that exceeds its limit. Withdrawing an overdraft that exceeds the company's limit as agreed by the bank is an unauthorized overdraft. It usually attracts unpleasant additional charges that may worsen the company’s financial distress. If the company continues withdrawing an amount that exceeds its limits regularly even after getting cautioned, other potential lenders may interpret such behavior as the company struggles to manage its credit. This may block it from accessing credit in the future (Andrew). When the company has a bad credit rating, it acts as a threat to the owners because when the company will need extra funds to boost its productivity in the future and no lender is willing to give it credit; the company risks provision of poor services or even closure and such a situation will have a direct negative effect to the owners because their source of revenue is on the verge of collapsing.

CHANGE IN FINANCE OPTIONS AND VALUATION CHANGES

DALMA IT Software Consultancy and Solutions commenced its services with 150 Euros raised by family and friends in 2011. This financing was appropriate at its early stage development because it is an easy way of raising funds since the company has not yet achieved a competitive advantage in the market, which can increase its value (Adam & Marek 9). Friends who give small loans to the business provide it without asking for security or accept less security, unlike banks. The funds may also be raised at a lower interest rate or even interest-free. Family and friends also agree to a much longer repayment period than formal lenders such as banks. They also do not need the business owners to provide a detailed business plan to raise the money, thus making this informal method of raising funds an easy one (NIBUSINESS INFO.CO.UK).

The shift in financing options from family and friends to overdraft facility and other lenders shows the business's admirable fast growth, giving it a competitive advantage in the market. The company experienced a 120% year-on-year growth since 2015. Now that it is in the maturity stage, it should focus on sustainability. This is because the application of sustainable business at all management levels, which comprise of all the functions and factors therein guarantees business continuity and also the power of value creation in the long term. It also ensures a dividend payout to shareholders that is sustainable and the creation of a social dividend to other stakeholders of DALMA IT software company.

When the business commenced, it only focused on entering into a contract with a few multinational firms that lasted for three or more years without a break clause. The main reason why it entered into a few deals with other firms is the limited working capital that could not allow it to tap other contract opportunities with other businesses. Besides, the contract between DALMA IT software company and a firm in the financial business sector that was worth a million Euros contributed significantly to the growth of the DALMA company, thus increasing its value. Now that the company's value has increased and the working capital, the company can enter into contracts with more businesses and even introduce new services that will boost their growth. It is also attracting new lenders without putting so much effort into attracting their attention, and this symbolizes that the company is headed in the right direction. Once the company has fully attained sustainability, it can consider opening the business in new locations. Through this, the company's continuity will be ensured, and its value in the market will continue to be strengthened.

ADVICE CONCERNING OVERDRAFT FACILITY AND OTHER ALTERNATIVE FINANCE OPTIONS USING A STRENGTHS AND WEAKNESS APPROACH

The main strength of an overdraft facility that separates it from other short-term financing options such as trade credit and short-term bank loans is that it provides immediate help to businesses in terms of cash flow to suffice their working capital expenditure. Therefore, an overdraft facility is the best option for the DALMA IT software company, which is in urgent need of increasing its working capital expenditure so that it can expand the provision of its services. Also, the facility is provided at an easy-repay feature and minimal documentation. In the case of a short-term bank loan, there would be more documentation that would consume a lot of time before the documents are approved and the credit issued. The overdraft facility's main weakness is that it offers a significantly lower amount of funds than a short-term bank loan. This situation gives short term bank loans an upper hand for a business that requires a high amount of extra funds. Trade credit also lacks an explicit interest rate attached; thus, many companies may prefer it because it is free credit. No additional interest above the face value of goods should be paid, making it the most favorable type of short-term financing (ACCA). Therefore, a business should weigh the different options that the types of financing options bring into the table and wisely decide which financing option will suit it.