Cash Flow For Alternative Financing
November 29, 2018
The statistics may indicate that the US economy has emerged from the recession, but many owners of small and medium-sized enterprises will tell you that they do not see a particularly strong recovery, at least not yet.
There are many reasons for the slow recovery of small businesses, but one of them is becoming increasingly apparent: the lack of liquidity caused by the longer payment terms introduced by their sellers. For many small businesses, dealing with slow paying customers is nothing new, but the problem is exacerbated in today’s slow economy and tense credit environment.
This is ironic given that many large companies have accumulated large cash reserves over the last few years, increasing their productivity and reducing their costs. In fact, several large high-profile corporations have recently announced that they are extending their payment terms up to four months, including Dell Computer, Cisco and AB InBev.
So here is a picture of the situation: Many large corporations are sitting on huge piles of cash and are therefore more capable of paying their resellers quickly than ever before. But instead, they extend their payment terms even further. Meanwhile, many small businesses are struggling to stay afloat, much less growing as they try to plug the cash flow gap while waiting for payments from their large customers.
How alternative financing can help
To help them cope with such cash flow challenges, more and more small and medium-sized enterprises are turning to alternative sources of financing. These are creative financing solutions for companies that do not qualify for traditional bank loans, but need financial support to help them manage their cash flow cycle.
Start-ups, fast-growing companies and companies with financial ratios that do not meet bank requirements are often particularly good candidates for alternative financing, which usually takes one of three different forms:
Factoring: In the case of factoring, companies sell their outstanding receivables to a commercial financial company (or factoring) at a discount, usually ranging from 1.5 to 5.5 per cent, which becomes responsible for managing and recovering the receivables. The company usually receives 70-90 per cent of the value of receivables in the case of sales to the factor and the balance (less the discount which represents the factor commission) when the factor collects the receivable.
There are two main types of factoring: full factoring and immediate factoring. With full-service factoring, a company sells all its receivables to a factor that performs a number of credit manager services, including credit controls, credit report analysis, invoice and payment dispatch and documentation.
Thanks to spot factoring, the company sells selected invoices for a given factor on a case-by-case basis, without any quantitative commitments. Since this requires more extensive controls, spot factoring is usually more expensive than full factoring. Full recourse, no recourse, no recourse, no recourse, notification and no notification are other factoring variables.
Receivables financing (A/R): A/R financing is more similar to bank credit than factoring. In this case, the company submits all its invoices to a commercial financial company, which creates a credit base on the basis of which the company can borrow money. Eligible receivables serve as collateral for the loan.
The credit base is typically 70-90 per cent of the value of eligible receivables. In order to be eligible, the claim must be less than 90 days old and the underlying company must be considered, inter alia, as capable of granting a loan by a financial company. The financial company charges a security management fee (typically 1 to 2 per cent of the outstanding amount) and charges interest on the amount borrowed.
Asset backed loans: This is similar to A/R financing, but the loan is secured by economic assets other than A/R, such as equipment, real estate and inventories. Unlike factoring, the company manages its own receivables and collects them, reporting monthly to the financial company on the ageing of the population. Interest is calculated on the amount of cash borrowed and certain fees are also valued by the financial company.
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