Ask any business owner; what is the single most essential component of a successful company, most would say adequate cash flow. How do most companies shipping goods and services on terms access working capital to improve cash flow? They almost always use some type of account receivable financing.
There are several ways to secure funding, however small business lines of credit are most popular method financing when using a traditional banks. Unfortunately in today’s difficult business climate banks are not lending, and when they are credit standards are much more restrictive. Businesses successful in establishing a small business credit line will have to pledge collateral, assets, such as accounts receivables, inventory, equipment, and fixtures to get financed.
In general, covenants come in two flavors: affirmative and negative covenants.
Affirmative covenants require a borrower to meet certain standards such as discharging contractual obligations and reporting information at regular intervals. Affirmative covenants usually require the borrower to pay the bank interest and fees, maintain its business, pay taxes, and so forth.
Negative covenants restrict the borrower from spending more than a specified amount on capital expenditures, increasing dividend payments, and they stipulate specific financial variables must satisfy certain minimums.
Covenants are being checked more frequently in today’s market place and many customers are finding themselves out of compliance with their banks.
Businesses finding themselves in this situation can look to Asset Based Lenders and/or Invoice Factoring companies as an alternate form of account receivable financing.
Asset Based Lenders will set up a very similar funding arrangement as your traditional bank with one exception, banks lend money and asset based lenders do not. The tag line is deceiving, however an asset based lender will purchase a companies invoices out right. They will advance funds against the purchased invoices, and typical initial advance rates are 80%. In addition, due to the size of the funding arrangements they will ask for additional collateral, such as inventory, equipment and fixtures.
Asset based credit lines look and feel very much like a small business credit line provide by a traditional bank with a few exceptions. First, asset based lenders require much more reporting and will require a remittance report for each and every advance. Second, the interest rate charge on the outstanding advance rate will be a few points more that a commercial bank line. Third, customers must remit payment to the asset based lenders lock box, and finally if sales slow your access to working capital slows.
The reason for this, the factor has already advanced on the company’s invoices, and as payments come in they will be used to pay down the outstanding balance.
The third type of account receivable financing is invoice factoring. This is the oldest form of financing and over many years has assisted small and mid-sized business to grow. Companies offering extended credit terms and wanting to grow will sometimes run into cash flow problems. They have too much money out on the streets and not enough in their bank accounts to pay suppliers, payroll, taxes and alike.
Invoice factors will step in and purchase a companies invoices at a small discount and provide immediate cash so the above expenses can be paid immediately.
Whether you elect to use a traditional bank, an asset based lender, or an invoice factoring company, businesses acquiring adequate account receivable financing will find managing cash flow much easier.
By: Darren Grady