Several financing options are available to companies that supply parts to the aviation industry. Your situation and objectives should determine the type of financing you use. This article reviews some financing options companies can use based on their challenges. The following topics are covered:
- What challenges are you trying to solve?
- How to improve cash flow
- How to handle large orders
- Which solution is right for your company?
1. What challenges are you trying to solve?
Business owners often think about getting a loan when their companies need financing. It’s understandable since business loans are the most well-known products. However, a business loan is not always the best solution.
The best strategy is to match the problem you are trying to solve to the solution that best solves it. Let’s use business loans as an example. Loans work well if your aircraft parts supplier wants to buy assets such as machinery (e.g., CNC machine).
However, loans won’t always work well if you have working capital problems or need funds to fulfill a large order. Other solutions are better suited to handle these specific problems. Let’s discuss two common financial problems for companies in the aviation industry.
a) Improving cash flow
Aviation suppliers often look for financing to help manage cash flow problems. This type of problem is best solved using a revolving line of financing. This approach enables you to accelerate your cash flow and handle expenses. We discuss options in section #2.
b) Handling large orders
Large orders can create problems because suppliers usually need to be paid before your customer pays you. Consequently, the funds to pay suppliers must come from your cash reserves. This payment method can create a problem if you get a stream of large orders or your cash reserves are insufficient.
This problem is best solved by using financing specifically designed to pay suppliers. The type of financing you use also depends on whether your company manufactures or resells the products.
2. How to improve cash flow
You can improve your cash flow by using a financing line that is secured against your receivables. A business line of credit works well, but they are difficult to obtain. Aviation parts suppliers that cannot qualify for a line of credit can consider using one of the following options.
a) Factoring
Factoring is commonly used by small and midsize aviation suppliers that need to improve cash flow. It allows you to sell your receivables to a factoring company. The factoring company advances funds against the receivables, which provides you with funds to run the business.
Transactions are usually done in two installments. The initial installment is called the advance and covers up to 85% of the value of your accounts receivable. The remaining 15%, less the factoring fee, is rebated once your customer pays in full on their usual terms.
The main advantages of factoring are that it improves your cash flow quickly and it has simple qualification criteria. The most important criteria are that your customers must have good business credit, and your invoices must not be encumbered by liens. To learn more, read “How Does Factoring Work?“
b) Ledgered line of credit
A ledgered line of credit is a revolving financing solution for companies that have outgrown factoring but are not ready for bank financing. Ledgered lines have several advantages over other solutions. They have better pricing than factoring lines but are easier to get than bank lines.
Ledgered lines work much like lines of credit secured by accounts receivable. They run on a borrowing base certificate that shows the amount of eligible receivables. Your company can draw from this line until it reaches a limit. Most ledgered lines are priced using a “Prime + X%” method.
3. How to handle large orders
Getting a large order can be a great opportunity for an aircraft parts supplier if your company has the funds to fulfill the order. However, the same order can be a major problem if your company lacks the funds to fulfill it.
The financing you use depends on how you sell the aircraft parts. Companies that resell parts should consider purchase order (PO) financing. On the other hand, companies that refurbish or manufacture aircraft parts should consider supplier financing.
a) PO Financing
Purchase order financing enables your company to fulfill large orders by handling your supplier payments. It helps companies that buy and resell aviation parts suppliers without additional services. The finance company pays your supplier directly. This arrangement enables your supplier to deliver the part and allows you to fulfill the order. The transaction can settle through a factoring line or when your end customer pays.
The main qualification requirements for PO financing are simple. Your client must have good business credit, your supplier must be reputable (e.g., FAA certified), and your profit margins must be over 25%. To learn more, read “What is PO Financing? How Does it Work?“
b) Supplier financing
Supplier financing is commonly used by manufacturing companies that need materials to manufacture their products. Companies that need materials request them through the finance company. The finance company intermediates the transaction by buying the product from your supplier and reselling it to your company for a small markup. Your company pays the finance company based on pre-negotiated terms.
This solution is available to companies that have been in business for a few years, meet the minimum order requirements, are profitable, and can be credit-insured. Supplier financing can be compatible with lines of credit as long as the line’s covenants do not restrict them. To learn more, read “What is Supplier Financing? How Does it Work?“
4. Which solution should you use?
Deciding which solutions work best for your company depends on your company’s current situation, line of business within the aviation industry, and expected needs. Here are some considerations.
Companies that need to improve cash flow should consider factoring or a ledgered line of credit. Qualifying for factoring is easier than qualifying for a ledgered line. Smaller companies or companies with moderate problems should consider factoring first. Midsized companies may be better served by a ledgered line.
Companies that need funds to pay suppliers should consider purchase order financing or supplier financing. Both solutions have very specific qualification criteria. PO financing works only if you resell aviation parts without refurbishing them and your margins are high. Otherwise, supplier financing may work in all other instances, as long as your company is credit insurable and profitable.
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Marco Terry is the Managing Director of Commercial Capital LLC and has over two decades of experience in asset-based finance. He has worked with small and mid-sized companies across the United States, Canada, and Australia. Marco holds a Master of Science in Finance.