Many small businesses have a cash flow emergency at one point or another. Unfortunately, these emergencies can even happen to companies that are well prepared. This article shows you how to obtain financing if your company needs immediate emergency funding. It also explains how to prevent some emergencies. We cover:
- What is causing your cash flow problem?
- How to finance gaps in cash flow
- How to finance large orders
- Prevent emergencies with a cash reserve
1. What is causing your cash flow problem?
Your first step is to identify the root cause of the cash flow problem. This step is essential because the solution you implement depends on the problem you are trying to solve. Otherwise, you could deploy a solution that doesn’t help you and could make things worse.
For example, cash flow problems due to growth are not solved in the same way as problems from slowing sales. Using strategies that would help a company with problems due to slowing sales could hurt a company with problems due to growth. This is why identifying the source of the problem is the first and most important step in solving this problem.
Two common cash flow problems can be solved with financing. The first problem occurs because commercial sales are made on net-30 terms or longer. Offering payment terms can lead to problems if the company cannot afford to wait that long for payment. The second problem happens when a company gets a substantial order. This type of order exceeds the company’s financial capabilities. Consequently, they can drain financial resources and create cash flow problems.
The next two sections explain how to handle these two common problems.
2. How to finance gaps in cash flow
Offering net-30- to net-60-day terms to customers can create a gap in your cash flow. This problem is common for companies that are growing quickly but don’t have a cash reserve. Gaps in your cash flow are best handled with a revolving line of financing. Revolving lines provide ongoing financing, enabling you to smooth operations and grow the business.
Two solutions can help with these problems – factoring and ledgered lines of credit. Small companies and companies with moderate financial problems should consider using invoice factoring. Midsized companies with few problems are better served with a ledgered line.
a) Invoice factoring
Small companies with cash flow problems due to slow-paying clients should consider invoice factoring. A factoring line allows you to leverage your receivables and get funds immediately. These lines are not loans. Instead, the factoring company buys your accounts receivable in exchange for immediate payment.
Most transactions are structured using two installments. When you submit the invoice, the factor advances 85% to 90% as a first installment. Once your customer pays in full, the factor remits the remaining 10% to 15%, less the fees, as a second installment. This installment settles the transaction. Learn more by reading “How Does Invoice Factoring Work?”
b) Ledgered line
Midsize and larger companies with cash flow problems should consider a ledgered line of credit. A ledgered line, also known as sales ledger financing, works like a line of credit secured against your accounts receivable. They are a hybrid product used by companies that have outgrown their factoring line but aren’t able to get bank financing. Ledgered lines are available to companies that invoice about $300,000 per month and don’t have significant problems.
The line enables you to draw funds as needed based on a borrowing base of eligible receivables. The borrowing base is dynamic and changes as you generate new invoices and older invoices get paid.
3. How to finance large orders
Getting a large order can create a problem for small businesses that don’t have enough funds to fulfill it. The business owner can fulfill the order but risks getting into financial problems. Alternatively, they can decline the order. However, their company will lose the order, the revenue, and, potentially, the client.
Some companies may have the option to finance their orders. You can use two options to finance purchase orders. The option you use depends on your line of business and your company’s financials.
a) Purchase order financing
Companies that re-sell goods to businesses or government agencies should consider purchase order (PO) financing. This solution covers the supplier costs associated with the order. It enables you to fulfill the order, close the sale, and book the revenue.
However, this solution has an important limitation. It cannot be used by companies that manufacture goods directly. PO financing can be used only by re-sellers. Manufacturing companies should consider supplier financing instead.
Purchase order financing transactions are structured so that the financing company pays your supplier costs directly. The transaction is settled once your end customer pays for the goods through a factoring line. Learn more by reading “What is Purchase Order Financing?”
To qualify for PO financing, your company must be a re-seller of goods. The goods cannot be modified or customized. Additionally, your profit margins must be above 20%, and the transaction must meet the financing requirements.
b) Supplier financing
Manufacturing companies that have to buy raw materials should consider supplier financing. This solution works with a financing company that intermediates the purchase and re-sells the raw materials to you. The financing fee is built into the sales price.
Supplier financing is available to manufacturing companies that are profitable. They must also be credit insurable and have a track record of delivering orders. Learn more by reading “What is Supplier Financing?”
4. Build an emergency cash reserve
You can solve some cash flow problems effectively by using financing. However, the best way to handle cash flow problems is by having and using an emergency cash reserve. The emergency reserve allows you to continue operations while you handle the underlying issue.
The process of building a cash reserve requires discipline but is not difficult. The first step is to determine the size of the reserve. Your industry, cash flow, and risk tolerance determine the reserve’s size. Consider speaking to a CPA if you are unsure about this.
Once you have determined the reserve’s size, build it by putting aside a small portion of your profits in a separate bank account. You can build the reserve slowly as long as you are consistent. Remember always to replenish the cash reserve whenever you use it.
Lastly, the financial options we described in this article can be combined with a cash reserve. This approach may enable you to have a larger effective reserve while keeping your funds employed.
Get more information
Have a cash flow emergency? We can provide you with a factoring line that has high advances at low rates. For information, get an online quote or call us toll-free at (877) 300 3258.