Today’s interest rates are extremely competitive. Unfortunately, companies aren’t able to take advantage of this low cost of capital. There are two reasons for this: First, customer demand is down and when customers don’t buy as much, and don’t buy as frequently, then a company must finance its inventory for longer periods. Second, when customers finally do make that purchase, they often take too long to pay, or don't pay at all. Either outcome forces a company’s receivable financing costs to increase. So, regardless of how low interest rates are, if customers aren't buying and aren't paying, then a company's cost of capital will increase. However, there are other options and they come in the form of ABL financing solutions like factoring, purchase order financing and inventory financing.
Each of these aforementioned options has become increasingly popular over the last 5 to 10 years. Again, low interest rates are a good thing, but if customers aren’t buying as much, and are taking too long to pay, then a company’s financing costs will surely increase. It’s a new reality and one that a number of companies are struggling with. As such, I thought I would put together the following video to provide some insight into these three aforementioned financing solutions. However, it’s important to make sure your company is comfortable with these options. Ultimately, you must do your homework and ensure that whatever option you choose, is something that works for your enterprise.
Factoring is a simple and straightforward option that allows companies to use the liquidity within existing unpaid customer invoices as a form of business credit. They can forego the hassle of waiting for customers to pay their bills, and instead use factoring as a means to reduce their cost of capital. A financing company essentially purchases your company’s invoice and in the process, they claim the right to collect on that invoice from your customer. You receive an advance on your receivable. Once your customer pays, your company is reimbursed the difference between the advance and the final payment. The fee charged is something you'll need to investigate, as there are varying options in terms of rates and lending conditions.
The above video is from the post: Sample Receivable Factoring Excel Sheet: Effective Rates & Interest Rates
Purchase order financing is another solution that allows companies to use existing orders, contracts and confirmed backlogs as a source of equity. They can use their existing sales volumes as a form of credit and secure the working capital needed to purchase the raw materials, parts and finished goods needed to complete current orders.
Finally, inventory financing is an option that allows companies to use their inventory as a form of collateral. However, a company can’t have issues with obsolescence, damage or theft. In essence, this option works for those companies with high inventory turnover rates, ones who are not impacted by cyclical and seasonal demand patterns. Your company must have a fast moving inventory and be able to provide proof of high turnover rates. Otherwise, if you encounter a slowdown in demand, you may be forced to liquidate your inventory to cover your established credit line. Personally, I am not a fan of inventory financing. After all, if you have high inventory turnover rates, then you have demand for product and should probably just use factoring. The rates on inventory financing are quite substantial and the borrowing limits are quite strict, so be sure to understand what you're getting into.
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