If your company manufactures things, you probably have issues with cash flow. Let’s face it. It takes a lot of money up front to make things. You have to pay for materials, labor, power, admin, shipping and all the expenses that go with producing a saleable product. Then, you sell it to a buyer who takes delivery and in 30 to 90 days sends you a check if all goes well.
As a result, many manufacturing companies have problems with cash flow. Every time you put out a new product and have to retool and reset production lines, you have costs that are not immediately recouped. So how do you make sure you have enough cash to buy materials, cover your subsidiary costs and pay your crew, especially in times when credit is tight?
Manufacturers are in a unique position among businesses in this respect. They have very high on-going expenses and at the same time carry very large accounts receivable that are uncollected. Large orders go with the territory in manufacturing. Customers pay by invoice and can take up to 90 days to pay. Meanwhile the manufacturer has very heavy ongoing costs and often has little ready capital to cover them. Financing is essential if manufacturers are going to stay in business.
Often manufacturing concerns rely heavily on bank loans and lines of credit for financing. In tight economic times, however, banks can be reticent about lending large sums of money, especially to companies that are new or that are struggling with the same economic factors as the banks.
A process called factoring is an alternate means of financing that lends itself particularly well to manufacturing businesses. Financing companies that specialize in factoring provide manufacturers cash or lines of credit based on the companies accounts receivable. Factoring works like this:
- The manufacturer provides the lender/factor records of its current outstanding invoices.
- The factor reviews the credit of customers with outstanding invoices and selects only those invoices the company feels comfortable buying from you.
- The factor financier tots up the total of the invoices it buys and sends you a percentage – say 50 to 99% of the total value of the invoices.
- When the payment comes in for the invoice, the factor takes out his percentage and sends you any balance due.
- One of the biggest benefits of factoring your invoices is that you get a percentage of your money immediately. This can be critical to maintaining your cash flow, especially during slowdowns in the economy, plant retooling or a slackening in sales.
- If you are a smaller manufacturer, it can save you tons of administration time, debt collecting and lost productivity. Having ready cash allows you to jump on new opportunities or start new production runs quickly and can minimize down time.
- Factoring can be a life-saver when your traditional bank financing gets tight or your credit picture doesn’t look so good.
The Price of Factoring
- Fees, interest and service charges can be quite high and significantly more so than a bank loan or overdraft line of credit.
- As the owner of the manufacturing business, you may be required to personally guarantee the debt. This can reduce your credit carrying capacity and ability to borrow traditional capital at lower cost. The factoring debt is secured over the most valuable cash-producing asset your business has – your accounts receivable.
- Factoring is limited by the total of your acceptable accounts receivable. If you experience rapid growth, factoring may not provide you with enough cash to keep up with operating and production costs.
- Because factoring is most attractive in tough economies, you run the risk that your bad debts may increase. If this happens, it can make factoring even more costly and reduce how much you are able to draw down against your receivables.
Factoring is a useful tool in your financial kit bag, but it is not the only one, and often, not even the best one. As with any type of credit, factoring should be used sparingly and only when you absolutely have to. The higher cost of cash obtained through the factoring process should always make you think carefully about it first.
Photo courtesy of kenteegardin via Flickr