Financing in a Cash Crunch
By CHICKMELIONfreelance
Your cash is tied up, yet you are facing an opportunity you just can’t pass up, a chance to expand into a new market or a capital investment you need in order to conduct your business efficiently and effectively. But these are wild and crazy times. You can hear the snap of the leather as business belts are tightening; banks and financial lenders being no different. Everyone is cracking down on their extensions of credit, and tightening up on their lending windows. You wonder what alternative options are available to you to move forwards with your plans. Where can you turn before your golden opportunity slips through your fingers?
Have you thought of Accounts Receivable Financing? It is another route you may want to consider in order to be able jump on that opportunity which has manifested it’s self to you. This is a form of short term borrowing, where an advance is made to a business as a loan or against the purchase of their accounts receivables. Most of the Fortune 500 companies have at one time or another opted for this form of financing, and it is currently an over three trillion dollar industry. It is prudent for you to know what you are heading into in order to negotiate the best arrangement for you and your business. After all this is a more expensive form of financing, and borrowing against your receivables inevitably lowers your profit margin. Your best strategy would be to mitigate those losses best you can. In order to do so, you should go into your meet and greet with your institution of choice armed with a fairly good understanding of where your portfolio’s strengths and weaknesses lie. It would help to understand the different avenues of financial institutions you can approach, and what type of product they offer in terms of purchase or loan agreements. You have to weigh the cost of the missed opportunity against the cost of this form of short term borrowing /or relinquishing of your assets, so you can make a decision of what best suits you and your vision.
Who do you go to? There are three options available to you and each on operates slightly different from the other. You can approach Banks, Financial Service Agencies, or the new kid in the block as of last year, “The Receivables Exchange.” Each one offers it’s pro’s and con’s in relation to the control and servicing of your receivable customers, the final costs of the agreements, the freedoms allowed you in terms of re-investing your cash allocations, as well as how they would qualify you and the receivable accounts you offer in trade. Everyone has their own benchmarks. It helps to have an idea where you fit before you decide to go in to negotiate.
A bank’s approach to Accounts Receivable/Inventory Financing (ARIF) is either via: a simple single advance note secured by a blanket lien on the receivables; or a fully followed assets based loan where the lender secures control over the borrower’s cash receipts and disbursements, as well as the quality of collateral. Generally the borrower still manages the accounts receivables, but is required to report to the lending institution on regularly regarding the status of the collateral for the term of the agreement. The bank’s advance rates are generally in between 70-80% of the receivables for what they define lower risk, but this depends on their view of the quality of the accounts. The rates can go down as their view of quality goes down. How the qualifications are applied will be looked at shortly. Safe to say the lower advance rates are applied when the lender perceives heightened risks of doing business with your accounts receivable clientele. They will look at the overall quality of your customer base, taking into account whether they are publicly rated companies, small privately owned companies, or individuals as consumers. Finally this type of financing is a loan , therefore you will be structured to payback the principle + interest + any service fees accrued. The rates on these types of loans are typically high so shop around!
Financial Service Agencies(FSA) use a technique called Factoring. And there is certain flexibility in the different type of factoring arrangements they offer, again shop around! Factoring involves the direct purchase of certain approved receivables altogether. Accounts which these agencies assess as a good gamble to invest in. They purchase these accounts at a discounted price, say on average 80% of the face value which it will pay to you the seller minus their service fees. Unlike the banks, the FSA assumes all credit risks for the purchased amounts, frequently performing all accounting functions in connection with the receivables and purchasers are notified to remit payments directly to the factor, (the FSA..) Hunt down large corporates who can offer better percentages because of economies of scale. There is at least one out there willing to deal you 90% on your “upstanding” invoices; who just dropped a press release mid August announcing a new program called “Kick Start”, which they say is an answer to the needs of small business in these recessionary times. It will provide working capital to help launch and grow small business... this corporation is Bibby Financial Services, and they are global.
As mentioned previously, there is a new player on the scene, they entered the market on November 2008. They are the The Receivables Exchange (TRE) and they are an online marketplace boasting of taking the running around out of negotiating the best fit for your needs, because they house all under one roof accredited institutional lenders in the market for purchasing receivables. TRE is in the business of buying and selling receivables through real time auctions. Sellers post one or more receivables, controlling the pricing parameters, set the minimum amount of advance they are willing to accept, as well as the maximum fee they are willing to pay. They also determine the length that their receivables are open for bid, (average 3-10 days.) There are entry requirements you have to meet in the application process, like having your doors open for business for a minimum of two years, as well as a minimum annual sales of no less than half a million dollars. If you fit into these benchmarks it will be well worth your time to look into the TRE’s website to get the full picture at: receivablesexchange.com. They are a good fit for the business who plans to finance through the selling of receivables more than once. There is a one time application fee, but no restrictions on how many times you use the exchange, but be careful to add up all the costs and see if it is worth it for you, if you are planning this type of financing as a one tome occurrence.
What information do you need to provide? You will be bringing with you your Financial Statements, recent tax returns, as well as your “aged” accounts receivables in the form of a report listing your accounts which details the current status of delinquency of the balance owed. Delinquency is commonly defines as 30,60, and 90 days over due relative to the terms listen on the invoice.
How will your accounts receivables be valued? It is important to understand before hand what all of these institutions will look at when determining what they are prepared to offer you and how they will structure their product package based on the information you provide. For you to effectively be able to negotiate and decide if you are getting a fair deal, understand what they are looking for as qualifications.
If it is a loan that you are looking to take out against your receivables, then the banks will take into consideration your purpose for the loan, your anticipated source of repayment as well as the quality of the receivables you lay down. Infarct all of the institutions will give a close look at this.. In addition, they will all look at your Cash Conversion Cycle. Even the Receivables Exchange will, when they qualify you in their application process. (I n it’s simplest terms, the cycle refers to the number of days between when a business pays for it’s materials/ inventory, and receives cash for these goods. It represents the time in which working capital is “tied up”).
None of them will even look at delinquent receivables older than 90 days, and would prefer to bargain on the cream of the crop sitting at 30 days.
In fact they will look closely at delinquency trends within the receivables base. Rising delinquency means increased risk, and may signal problems with the borrower and their capacity to collect. That is going to affect your advance percentages if not your eligibility altogether.
They will scrutinize your business, your industries performance in the current economic environment at the time of the application, as well as your position within this industry, along with your customer base. In general the greater amount of financially sound companies, the better the quality of the customer base. They will also look for concentrations within this base. If a few number of companies or people produce the majority of the receivables it is frowned upon, because if they take their business elsewhere, you might fall flat on your face.
They will check for lien searches some will even ask for a criminal records search, and they will be looking in particular for registrations of “purchase money interests”and
“tax liens,” because these take legal priority over a lender’s lien, or an outright purchaser
What would put a smile on everyone’s face is if the receivables have a 3rd party guarantee or insurance. Understandibally it is a good card up the sleeve for negotiations, because these guarantees reduce the risks, and there by justifiably support higher advance percentages. Some examples of these types of guarantees or insurance are government sponsored and private insurance programs. No doubt these can significantly influence eligibility considerations.
Big, big red flags: are accounts which are government receivables; foreign receivables (because they hold legal risks); affiliate transactions (because financial conditions of the affiliates mat deteriorate simultaneously); or contra- accounts (when you both sell to and purchase from the same customer.) All these accounts are deemed intelligible for consideration.
And finally compliance risks are taken into account as well. For example: the possibilities and risks for non-compliance with federal or state laws , rules, or regulations, which may cause your business to suffer setbacks. What if you violate or fail to conform to environmental, health, safety, or labor laws? In addition litigation and other legal remedies that may arise when the lender/purchaser seeks to have a debt liquidated.
Know what you hold in your accounts receivable portfolio. Even if you are not at the moment considering Accounts Receivable Financing , it may serve you well to look at some of the issues put forth and tighten up on the areas that you feel may currently not stack up in respect to these accounts, it can only improve your bottom line right off the bat. In addition you will be in a better position to jump onto any opportunity that may present it’s self without any warnings, by negotiating with receivables that are considered to be cream in the industry.
