Managing the cash flow of an oilfield services company can be a demanding task. The oil and gas industry is dynamic, with periods of fast growth usually followed by sharp slowdowns. In this operating environment, small and midsize companies can face cash flow problems when their growth gets ahead of their financial capabilities. This article addresses the most common cash flow problem and covers two ways to solve it. We discuss the following:
- A common working capital problem
- Can your customers pay sooner?
- Finance invoices with factoring
- Advantages of factoring
- Can your company qualify?
1. A common working capital problem
Most companies in the energy industry pay their vendor invoices on net-30 to net-60 terms. While getting payment terms from large clients is typical, payment terms can create cash flow problems for oilfield services companies with small cash reserves. These companies cannot wait up to 60 days for payment because they need immediate funds to pay ongoing expenses.
This problem becomes more complex because the energy industry is cyclical. It has periods of fast growth, followed by slowdowns. Companies without significant cash reserves can have difficulties managing these cycles. Consequently, they become exposed to cash flow problems that will worsen if not fixed.
2. Can you ask customers to pay sooner?
The simple solution to this problem is to ask your customers to pay sooner. Making this request to clients is difficult since paying your invoice sooner affects their cash flow. It’s to their advantage to pay you in 30 to 60 days. Furthermore, larger companies may threaten to take their business elsewhere if you demand quick payments.
However, you can ask clients to pay sooner if you give them a discount as an incentive. This practice is commonly referred to as an early payment discount. When used correctly, early payment discounts can be an effective way to improve your cash flow.
Early payment discounts are simple to use. The customer gets a discount, usually 2% off the invoice, if they pay in less than ten days. Otherwise, they pay the face value of the invoice on their usual terms.
Early payment discounts have some limitations. The most important limitation is that they are optional. Your customer pays early only if they choose to. Furthermore, they will likely stop paying quickly during challenging economic times – just when your company needs quick payments the most.
3. Finance invoices with factoring
Early payment discounts can work well for companies with minor cash flow problems. However, they aren’t always reliable and may not provide consistent cash flow during a time of need. Oilfield services companies that require consistent cash flow should consider invoice factoring.
Factoring enables companies to finance their invoices. This solution provides you with immediate working capital that can be used to cover expenses and take on new clients. Factoring is common in the oil and gas industry. It’s used by oilfield service companies, transportation companies, and pipeline construction, among others.
How does factoring work?
Factoring works differently from the way that most conventional financing solutions work. Transactions are structured as the sale of an asset rather than as a loan. This difference is important because it allows for simpler underwriting and faster deployment of funds. Your company sells its invoices from creditworthy clients in exchange for an immediate payment.
Factoring companies usually buy the invoice in two instalments. The first instalment is called the advance. It covers about 85% of the invoice value and is deposited into your bank account shortly after selling the invoice. The remaining 15%, less the factoring company’s fee, is deposited into your bank account once your client pays the invoice. The second instalment settles the purchase of the invoice. To learn more, read “What is Factoring?”
4. Advantages of factoring your invoices
Factoring has several advantages over other financing solutions. The following advantages are the most important:
a) Solves cash flow problems
The most important benefit is that the solution solves cash flow problems from slow-paying customers. It is very effective at quickly solving this specific problem.
b) Easier to obtain than loans
Factoring lines are easier to obtain than comparably sized bank financing facilities. The due diligence process is simple, and factoring lines don’t have onerous covenants that you must comply with. Most small companies that don’t have serious problems have a good chance of qualifying.
c) Dynamic sizing
The line size is dynamic and adapts to fast-changing businesses. It’s ideal for an industry that has fast-paced growth periods. This line size can easily be increased to match your revenues as long as you deliver quality work/products to creditworthy companies.
d) Deploys quickly
Factoring lines can be deployed quickly due to their simplified underwriting process. Smaller lines may be deployed in as little as a week as long as the factoring company receives all the information promptly. Larger lines or more complex transactions, such as turnaround situations, may take longer.
5. Can your company qualify?
Qualifying for a factoring line is easier than qualifying for a conventional financing product of the same size. A company should meet these criteria:
a) Works with creditworthy companies
Your customers should have a good track record of paying their invoices in 30 to 60 days. Factoring companies usually verify the creditworthiness of your invoices using a credit bureau such as Dun and Bradstreet.
b) A/R not secured by another company
Your company’s accounts receivable must be clear of any liens or hypothèques. A subordination will be required if your accounts receivable are pledged as collateral for another facility.
c) Does not have serious problems
Factoring can be used in turnaround transactions as long as the company is not at immediate risk of insolvency. The solution can work as a stepping stone that enables the company to improve its financial stability and eventually qualify for conventional financing.
d) Has profit margins above 20%
Factoring works best for invoices that pay in less than 60 days and have a profit margin of 20% or more. It can be used in other circumstances as long as the profit margins support it.
Get more information
We are a leading factoring provider in Canada and can offer competitive financing plans to oilfield services companies. For more information, call us toll-free at (877) 300 3258 or get an online factoring quote.