Summary: Manufacturing companies are usually resource-intensive businesses. They require substantial financing to get started, operate, and expand. This creates an ongoing financial need that burdens many small manufacturing companies.
This article covers six financing alternatives to finance different aspects of your manufacturing business. We cover the following:
1. Overview
Some financial products can be used as general-purpose solutions. These products tend to get the most media attention because of their flexibility. However, their flexibility comes at an expense. These products have stringent qualification requirements that put them out of the reach of many small companies.
In reality, most financial products are designed to fix a specific type of problem. While not general-purpose solutions, these products are very good at solving the specific issue they were designed to address. They also tend to have simpler qualification requirements and be more accessible to small manufacturing companies.
a) What is the best strategy?
In our experience, the best strategy for small companies is to use the product that is best fitted to solve the specific problem you are trying to fix. This strategy helps you select the best solution for your specific challenge.
The following section covers two general-purpose solutions that can help in most cases. The sections after that cover focused products that help solve the three most common challenges for manufacturing companies: cash flow, raw materials, and equipment.
2. General purpose financing
The most flexible solutions for manufacturing companies are SBA financing loans and asset-based loans. We consider these two options ‘general purpose’ financing because they can be used to fit multiple objectives.
a) Small Business Administration financing
The Small Business Administration (SBA) has several options to help companies. Note that the SBA does not finance transactions themselves. Instead, they provide guarantees to financial institutions. These guarantees enable the lender to provide competitively priced solutions.
The SBA offers several options with differing requirements. Manufacturing companies that need less than $30,000 should consider a Microloan. This solution has simple qualification requirements that are ideal for small companies.
Companies with larger or more complex needs should consider the 7(a) program. These general-purpose loans can be used to improve cash flow, acquire or improve assets, or even acquire other companies. We consider them to be the most flexible SBA solution.
Lastly, companies that only need to buy or improve fixed assets like equipment and real estate can also consider a 504 loan. You can find more information here.
b) Asset-based loans
Asset-based lending provides financing to midsize manufacturing companies. It is a general-purpose solution that allows companies to finance their accounts receivable, machinery, inventory, and other assets.
Lines are structured based on the assets that are being leveraged. Generally, lines based on accounts receivable and inventory are structured to resemble a revolving line of credit. This structure allows you to get funds and repay based on availability.
Facilities based on machinery and other assets often have a term loan structure. Your company gets a set amount, which is paid back in installments.
ABLs that combine assets often have several facilities. A term structure is used for fixed assets, while a revolving structure is used for accounts receivable and inventory. Read “What is an asset-based loan?” to learn more.
3. Finance cash flow
Manufacturing companies looking to improve cash flow can also consider a specialized type of product to fix this problem. Lines of credit are considered the best type of product for this challenge. However, lines of credit can be out of reach for small manufacturing companies due to their challenging qualification requirements.
Invoice factoring and ledgered lines of credit can often meet the requirements of manufacturing companies while having simpler qualification requirements. We will cover these solutions next.
a) Invoice factoring
An invoice factoring line allows you to finance your accounts receivable. The line enables you to finance invoices typically paid in 30 to 60 days. It provides funds that you use to operate the business.
Most factoring companies finance accounts receivable using a two-installment structure. The first installment covers up to 85% of the invoice. It is paid as soon as the product is delivered to the client.
The remaining 15%, less the factoring fee, is paid once your client pays the invoice in full. This settles the transaction for the invoice. Most companies use factoring regularly as a revolving solution.
Factoring is easier to get than most financing products. The main requirement is to work with creditworthy commercial clients. Aside from that, your invoices cannot be encumbered by any liens. Read “How does invoice factoring work?” to learn more.
b) Ledgered line of credit
A ledgered line of credit, or sales ledger financing, is an intermediate product between invoice factoring and a line of credit. It operates like a revolving line of credit secured by A/R.
Most ledgered lines use a borrowing base determined by your eligible A/R. You can borrow up to 85% of the base by making draw requests to the finance company. The borrowing base is flexible and can adapt to growing revenues.
The qualification requirements for a sales ledger financing line are simpler than a line of credit. Companies must have minimum yearly revenues of a few million dollars, reliable financial statements, and be free of major issues.
4. Finance raw materials
Supplier financing is a form of supply chain financing that helps manufacturing companies purchase raw materials. This enables them to increase production and fulfil more purchase orders.
The line operates through a finance company that intermediates your raw material purchases. The finance company buys materials from your supply chain on your behalf. Then, the finance company extends trade credit to your company and resells the product to you. Your company has up to 90 days to pay the invoice.
Supplier financing does not create debt. Instead, it creates a trade payable. It can typically be used alongside most other types of financing. It usually won’t interfere with your lending covenants, though you should check. Read “What is supplier financing?” to learn more.
To qualify, companies must have:
- Three years of operation
- Yearly sales of 2 million dollars or more
- The ability to get credit-insured
- Adequate financial statements.
5. Finance equipment
Manufacturing companies that need to finance machinery have several options. They can use a SBA loan, as discussed in the first section. They can also use bank financing. Several lenders offer competitive programs.
However, small manufacturing companies may not be able to qualify for lender financing. These companies can consider leasing. In a leasing transaction, the finance company buys the machinery and leases it back to your company. Your company pays a monthly fee to use the equipment.
You have two potential options at the end of the lease. Some leases allow you to buy the machinery outright for a nominal payment. Alternatively, other leases may require that you return the equipment.
Does your manufacturing company need financing?
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Note: This article is not intended as financial advise. Consult with your finance team or a CPA if you are unfamiliar with these options or require advise specific to your situation.