Financing in a Cash Crunch

Accounts Receivable Financing is a Route You May Want to Consider

By Carla Maria Dummerauf, Owner of CHICKMELION freelance

Your cash is tied up, yet you are facing an opportunity you just can’t pass up, a chance to expand into a new market or a capital investment you need in order to conduct your business efficiently and effectively. But these are wild and crazy times. You can hear the snap of the leather as business belts are tightening; banks and financial lenders being no different. Everyone is cracking down on their extensions of credit, and tightening up on their lending windows. You wonder what alternative options are available to you to move forwards with your plans. Where can you turn to before your golden opportunity slips through your fingers?

Accounts Receivable Financing

This is another route you may want to consider in order to be able jump on that opportunity which has manifested itself to you. This is a form of short-term borrowing, where an advance is made to a business as a loan or against the purchase of its accounts receivables. It is prudent for you to know what you are heading into in order to negotiate the best arrangement for you and your business. After all, this is a more expensive form of financing, and borrowing against your receivables inevitably lowers your profit margin. Your best strategy would be to mitigate those losses best you can. In order to do so, you should go into your meet and greet with your institution of choice armed with a fairly good understanding of where your portfolio’s strengths and weaknesses lie. It would help to understand the different avenues of financial institutions you can approach, and what type of product they offer in terms of purchase or loan agreements. You have to weigh the cost of the missed opportunity against the cost of this form of short term borrowing or relinquishing of your assets, so you can make a decision of what best suits you and your vision.

Who Do You Go To?

There are three options available to you and each on operates slightly different from the other. You can approach Banks, Financial Service Agencies, or “The Receivables Exchange.” Each one offers its pros and cons in relation to the control and servicing of your receivable customers, the final costs of the agreements, the freedoms allowed you in terms of re-investing your cash allocations, as well as how they would qualify you, and the receivable accounts you offer in trade.

A bank’s approach to Accounts Receivable/Inventory Financing (ARIF) is either via: a simple single advance note secured by a blanket lien on the receivables; or a fully followed assets-based loan where the lender secures control over the borrower’s cash receipts and disbursements, as well as the quality of collateral. Generally the borrower still manages the accounts receivables, but is required to report to the lending institution regularly regarding the status of the collateral for the term of the agreement. The bank’s advance rates are generally in between 70%–80% of the receivables for what they define lower risk, but this depends on their view of the quality of the accounts. The rates can go down as their view of quality goes down. The lower advance rates are applied when the lender perceives heightened risks of doing business with your accounts receivable clientele. They will look at the overall quality of your customer base, taking into account whether they are publicly-rated companies, small privately owned companies, or individuals as consumers. Finally this type of financing is a loan; therefore you will be structured to pay back the principle + interest + any service fees accrued.

Financial Service Agencies (FSAs) use a technique called Factoring which involves the direct purchase of certain approved receivables altogether. They purchase these accounts at a discounted price, say on average 80% of the face value which it will pay to you the seller minus their service fees. Unlike the banks, the FSAs assume all credit risks for the purchased amounts, frequently performing all accounting functions in connection with the receivables, and purchasers are notified to remit payments directly to the factors, (the FSAs).

The Receivables Exchange (TRE) is an online marketplace at receivablesexchange.com, which houses under one roof all the accredited institutional lenders in the market for purchasing receivables. TRE is in the business of buying and selling receivables through real time auctions. Sellers post one or more receivables, control the pricing parameters, and set the minimum amount of advance they are willing to accept, as well as the maximum fee they are willing to pay. They also determine the length that their receivables are open for bid (average 3–10 days.). There are entry requirements you have to meet in the application process, like having your doors open for business for a minimum of two years, as well as a minimum annual sales of no less than half a million dollars.

What Information Do You Need To Provide?

You will be bringing with you your financial statements, recent tax returns, and your “aged” accounts receivables in the form of a report listing your accounts and detailing the current status of delinquency of the balance owed. Delinquency is commonly defines as 30, 60, and 90 days overdue relative to the terms listed on the invoice.

How Will Your Accounts Receivables Be Valued?

For you to effectively be able to negotiate and decide if you are getting a fair deal, understand what institutions are looking for as qualifications. If it is a loan that you are looking to take out against your receivables, then the banks will take into consideration your purpose for the loan, your anticipated source of repayment, and the quality of the receivables you lay down. In fact, all of the institutions will give a close look at this. In addition, they will all look at your Cash Conversion Cycle. Even TRE will, when qualifying you in the application process. (In its simplest terms, the cycle refers to the number of days between when a business pays for its materials/ inventory and when it receives cash for these goods. It represents the time in which working capital is “tied up.”)

The institutions will not look at delinquent receivables older than 90 days, and they would prefer to bargain with those sitting at 30 days. They will look closely at delinquency trends within the receivables base. Rising delinquency means increased risk, which may signal problems with the borrower and the capacity to collect. That is going to affect your advance percentages, if not your eligibility altogether.

The institutions will scrutinize your business and your industry’s performance in the current economic environment at the time of the application, as well as your position within the industry and your customer base.  They will check for lien searches. Some will even ask for a criminal records search, and they will be looking in particular for registrations of “purchase money interests” and “tax liens,” because these take legal priority over a lender’s lien, or an outright purchaser.

What would put a smile on everyone’s face is if the receivables have a 3rd party guarantee or insurance. This reduces the risks, and thereby justifiably supports higher advance percentages. Some examples of these types of guarantees or insurance are government-sponsored and private insurance programs. No doubt these can significantly influence eligibility considerations.

Know what you hold in your accounts receivable portfolio. Even if you are not at the moment considering Accounts Receivable Financing, it may serve you well to look at some of the issues put forth and tighten up on the areas that you feel may currently not stack up in respect to these accounts. It can only improve your bottom line.