For many small business owners, getting paid promptly is the key to their financial success. However, over the last few years, an unfortunate trend has been affecting millions of small businesses across the United States. The issue of “Extended Payment Terms”, which literally means deferring payment by a business to your suppliers in order to better manage short-term cash flow, is a problem far too many suppliers and vendors have been seeing firsthand. In this much-discussed Wall Street Journal article, we learn how multinationals and large businesses often delay their payments to intermediaries down their supply chain for materials or services provided to them. The reason for this? Conventional wisdom would say that large enterprises have market power advantage allowing them to forcefully dictate their relationships with smaller entities. If a small business does not agree or cannot produce what is promised, the large enterprise can just find another supplier from a long list of suitors, and leave their previous partner struggling to secure other contracts.
Now, if you are a Chief Financial Officer (CFO) at a large enterprise, extending payments to 90 or 120 days (or more) can help your cash management strategy by freeing up capital. This added capital contributes to their cash flow and allows them to fund expansions or undergo financial restructuring. Obviously, this places the small business (2nd or 3rd tier) suppliers and vendors in a difficult position. Many of these businesses deal with inventory or cash-to-cash cycle issues throughout the year. With these added constraints, these small businesses are feeling the financial squeeze, and unable to grow and manage their business at the pace that they desire.
For years, an option many of these small businesses have had is “factoring” their receivables. This process usually works by a business selling its accounts receivables or invoices to a third party lender at a discount. In some cases, this makes sense. For example, if your business needs to cover financial obligations and operational costs for 30 or 60 days. I will argue, however, that if you need to finance working capital constraints for anything more than a few months you might want to think about a line of credit.
Typically, lines of credit are secured against accounts receivables, inventory or machinery and equipment. This collateral mitigates the risk for the lender. If you are a manufacturer, supplier or vendor in aerospace, automotive, consumer products, transportation or waste management, then your inventory or equipment can be used to grow your working capital. Having a line of credit, especially with a lender that only charges on the amount withdrawn, can alleviate liquidity problems due to customers pushing payments to 120 days or more. Again, this is a trend many businesses are moving towards.
I often say that we are in a dynamic time in finance. If you are a CFO or Controller, there are a myriad of options available to you to help drive growth for your business. At The Credit Junction, we offer a monthly interest-only payment on the amount drawn of your line of credit from $500K up to $5M. For more information, you can email me at email@example.com