Why cash flow is king
From here, the dominos quickly started falling: The company fell behind in paying its suppliers, who soon refused to ship raw materials. Without materials to manufacture more products, sales soon plummeted. And when it started missing payroll, key employees walked out the door. Less than one year after opening with so much potential, XYZ Company shut its doors—another victim of the destructive effects of a lack of cash flow.
Commercial Financing Alternatives
In a perfect world, small businesses would be able to access a bank line of credit to provide the working capital they need to see them through cash flow shortfalls like the one experienced by XYZ Company. But in the current economic environment, many companies that would have qualified for bank financing a few years ago no longer meet banks’ more stringent underwriting guidelines.
Instead, many are now turning to alternative financing vehicles to provide the financing boost they need to manage their cash flow cycle. These alternative financial vehicles include factoring, accounts receivable (A/R) financing and asset-based lending.
With factoring, small businesses sell their outstanding accounts receivable to a commercial finance company (or factor) at a discount. Instead of waiting 60-90 days or longer to get paid, the business receives most of the cash (usually 70-90 percent of the receivable) when the invoice is generated. The factor remits the balance (less the discount) after it collects the invoice.
A/R financing is similar to a bank loan or line of credit. The business will submit its invoices to the lender, which establishes a borrowing base of usually 70-90 percent of the qualified receivables—this is the amount the business can borrow against the eligible A/R. The lender will usually charge a collateral fee and interest on the amount borrowed.
With asset-based lending, the loan is secured by business assets (e.g., equipment, real estate, accounts receivable and inventory) with interest also charged on the amount borrowed, as well as certain fees. The business is able to borrow against more of the assets of the company, giving it access to more capital.
The business collects and manages its own receivables, instead of selling them to the factor, while submitting a monthly aging report to the lender. There are usually tighter constraints by the lender due to the greater leverage that is allowed.
Real or Paper Profits?
The takeaway is simple: Don’t focus disproportionately on all the profits that are showing up on your profit and loss statement. Sure, every business wants to make money, but make sure your profits are real, not just on paper.
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