Summary: Most industrial and commercial clients pay invoices on net-30 terms. However, offering net 30 terms can create cash flow problems for machining companies that aren’t well capitalized. This article shows how you can solve this problem by improving operations and financing your invoices. We cover the following:
- Are you offering payment terms?
- Simple ways to improve cash flow
- How to finance invoices
- Benefits of factoring
- Disadvantages of factoring
- Qualification requirements
- Other alternatives
1. Are you offering payment terms?
One of the biggest challenges of working with an industrial client base is that they often require payment terms. Payment terms give your clients 30 to 60 days to pay their invoices. They are a common way of doing business, and most large companies expect them.
Offering net-30 terms to clients is not a problem for most machining and metalworking companies. They can use their cash reserves to handle operating expenses until the invoice is paid.
This situation is different if a company is growing quickly or has a small cash reserve. They may not have sufficient funds in reserve to cover operating expenses. This situation can create serious cash flow problems.
Most managers react to this situation by delaying vendor payments. This allows them to conserve cash while focusing on essential expenses only. While this strategy provides a temporary solution, it does work in the long term. It may also prompt your vendors to tighten credit terms, creating problems later on.
A better approach is determining if you can fix your cash flow issue by improving your business processes. This can provide a long-lasting solution. If this strategy doesn’t work, consider financing your accounts receivable.
2. Simple ways to improve cash flow
There are two simple ways to improve your cash flow without using financing. These strategies can work well, provide long-term results, and are cost-effective. However, they don’t always solve the problem completely.
a) Invoicing and collections
Invoicing clients promptly and collecting payments effectively are essential to every business. However, they require discipline that may be difficult to maintain if the company is going well or growing quickly. This eventually leads to problems.
The best way to handle slow-paying customers is to try to avoid them in the first place. You accomplish this by incorporating the following into your invoicing and collections:
- Use a well-written contract
- Check the client’s business credit
- Get a signed delivery acceptance from clients
- Invoice promptly
- Follow up regularly
b) Offer discounts for early payments
Companies whose invoicing and collections are working well can further improve their cash flow by offering early payment discounts. These provide clients with a 2% (varies) discount if they pay an invoice within ten days. This incentive can work well if you work with established clients.
Offer this benefit to your best clients. It will improve their level of customer satisfaction while helping your cash flow. Avoid offering this benefit to your worst-paying client typically. It seldom improves their performance and can backfire.
One disadvantage of early payment discounts is that your client chooses if and when to use them. You will never be 100% certain if they will pay early on any given month.
This strategy works well if your cash flow issues are minor or temporary. However, consider using financing if you need more reliable and flexible financing.
3. How to finance invoices with factoring
Invoice factoring is a type of financing that helps small and midsize machining and metalworking companies improve their cash flow. It is a reliable form of financing that works well for manufacturing companies.
This solution works by financing invoices from creditworthy industrial and commercial clients. It leverages your accounts receivable and provides funds to cover operating expenses and to take on new opportunities.
a) How does it work?
Most factoring transactions are not structured as loans. Instead, your company sells its accounts receivables to a factoring company. The factoring company pays for the invoices immediately, which accelerates your cash flow.
Factoring transactions are usually financed in two installments. The first installment covers 85% of the invoice. The funds are deposited into your account once you invoice your clients for the completed work.
The second installment covers the remaining 15%. This installment is deposited into your account, less the factor’s fees, once the invoice is paid. This deposit settles the transaction for the invoice.
Most companies factor their invoices in regular batches (e.g., weekly) rather than individually. This is easier to manage while also providing the machining company with ongoing financing.
Read “What is factoring?” and “How does invoice factoring work?” to learn more.
4. Benefits of factoring
While factoring plans have several benefits, there are four main reasons why companies use them. They are the following.
a) Improve cash flow quickly
The main benefit of using factoring is that it can improve your cash flow quickly. Consequently, the lines can be used by machining and metalworking companies that need immediate financing.
b) Grows with your business
Factoring lines are tied to your accounts receivable. They are designed to be adaptive and can grow as your business grows.
c) Simple qualification criteria
Factoring has simple qualification criteria. The solution is available to small and growing manufacturing companies that may not be eligible for bank financing.
d) Can be deployed quickly
Most factoring plans can be deployed in one to two weeks. This works well for manufacturing companies that need financing quickly and cannot go through the typical bank underwriting timeframe.
5. Disadvantages of factoring
Managers should always balance a financing solution’s advantages against its disadvantages. Factoring lines have two main disadvantages that companies should consider.
a) Factoring is expensive
Factoring lines can be expensive compared to other solutions, such as lines of credit. They work best for companies whose margins exceed 20% (varies) and whose invoices pay in 45 days or less. In our experience, most machining and metalworking companies have profit margins that are high enough to meet these criteria.
b) Solves only one problem
A factoring solution can help a company whose cash flow problem originates from slow-paying clients. This solution won’t work well or provide a long-term solution for companies whose cash flow problems are due to other issues, such as unprofitable products.
6. Qualification requirements
The qualification requirements for a factoring plan are simpler and easier to meet than those of other solutions. In general, factoring companies focus on three areas of your business.
a) Do your customers have good commercial credit?
Factoring companies carefully examine the business credit of your customers. They only buy invoices that have a good credit score. Consequently, factoring will work for you only if your customers have good credit.
b) Are your invoices encumbered?
Factoring companies cannot buy your invoices if they are encumbered by UCC liens from lenders or tax authorities. The factoring company will need to work out a subordination with the lien holder.
Note that machining and metalworking companies typically use equipment financing to finance equipment. Usually, these facilities are secured only by the equipment and don’t encumber accounts receivable. Check with your lender if you are unsure.
c) Does your company have tax or legal problems?
Factoring companies can work with clients with tax issues as long as a payment plan is in place. They can also work with companies with legal problems, provided these are not serious.
7. Other options
Factoring is a great solution to improve cash flow and needs to be used strategically. It should help you stabilize and grow the business and work as a stepping stone to conventional financing. Companies that have outgrown their factoring lines should consider a ledgered line of financing. Alternatively, they may have enough of a track record to qualify for a commercial line of credit.
Get more information
We are a leading factoring company and work with machining and metal working companies. For information, get an instant quote or call us at (877) 300 3258.