6 Reasons to Embrace Alternative Financing

Manufacturers need to shorten DSO and increase cash flow, without the constraints of traditional financing.

While economic conditions may be marginally better than a year ago, the road to full recovery for manufacturers will not be straight and smooth. Particularly for small and mid-sized companies, the financial landscape has changed dramatically since 2008. Many manufacturing companies are finding it harder than ever to get working capital on their terms using traditional methods.

As a vital component of the U.S. economy, manufacturing accounts for 11% of GDP and contributes 13.5% of all private sector jobs. However, currently the lending environment is severely limiting manufacturers’ access to capital and credit to fund day-to-day operations or capitalize on upcoming growth opportunities.

According to the 2010 RSM McGladrey Annual Manufacturing and Wholesale Distribution National Survey of over 1,061 manufacturing executives, 19% of respondents reported difficulty securing credit. For companies with less than $25 million in annual revenue, the squeeze is especially tight, with 29% of leaders reporting limited lending conditions. It should come as no surprise that executives who report a lack of available financing were also likely to say their companies will not recover until 2011 or beyond.

Most manufacturers are used to facing cash-flow constraints. On one end you’re dealing with suppliers that demand quick payments, on the other end are customers that want to pay invoices in net 60 days and beyond — both are doing what they can to protect their own cash flow. For large suppliers and manufacturers who have business financing or large cash reserves, juggling the time lag between Accounts Payable and Accounts Receivable is usually not a problem. However, that sort of juggling can be a serious challenge for small and “middle market” manufactures that don’t have adequate financing, or have minimal cash reserves.

Manufacturers need access to working capital for new or expanded facilities, new hires, raw materials, material discounts, and for equipment needed to build capacity and remain competitive. Fortunately, innovative alternative financing options are available to manufacturers to help them better manage cash-flow constraints and gain access to working capital to fund growth and success. Here are six reasons why alternative financing can be superior to traditional financing sources (such as banks, ABLs, factors), and is becoming a “best practice” for financial decision-makers in the manufacturing sector:

Banks aren’t lending
One of the enduring effects of the ongoing financial crisis is that credit remains scarce for small and mid-sized businesses, even those with strong financials and cash flow. In 2009, when the crisis was in full swing, bank lending fell $587 billion, or 7.5%, according to the FDIC. There are some indications that banks are starting to lend to small businesses again, but these increases are modest, and lending is nowhere near pre-recession levels. What’s more, many banks – especially community banks that small businesses rely on for financing – are failing. In March 2011, the number of banks in the U.S. that were in danger of failing hit 985, the highest level since the beginning of the financial crisis three years ago. This credit tightening has disproportionately harmed small and mid-sized businesses, which traditionally have had fewer options than large companies for raising capital and rely heavily on bank credit. According to the 2011 Mid-Year Economic Report published by the National Small Business Association (NSBA), 36% of small companies—including many manufacturers—report they are unable to get adequate financing for their business.

Large companies that rely on bank financing typically have had an easy time accessing credit. But, according to the RSM survey, many large manufacturers are concerned about more restrictive credit standards hindering business development. For example, while only 15% of executives in companies with annual revenue of $100 to $250 million reported concern about credit availability, two-thirds of those leaders were worried how tight credit will affect future growth.

In this context, it’s important to have a financial strategy that is flexible, affordable, and will not saddle you with onerous constraints. Fortunately, there are many innovative alternatives to traditional financing that can help businesses get the cash they need to fund operations and fuel growth.

Traditional financing isn’t as cheap as you think
If you own or manage finances for a business, chances are you have bank financing, or you’ve applied for it in the past. Bank financing is widely regarded as a cheap and simple way to fund a business, but often it comes with hidden charges and penalties that most businesses do not factor into their costs. Some loans require you to make a down payment and pay sales tax on the loan in advance, which can be a significant upfront cost. You can incur penalties for missing a payment, or for paying early, whether to alleviate your debt or refinance. Add to these the processing fees, documentation fees, third-party fees, and government fees and taxes associated with loans and lines of credit, and the costs could add up to far more than merely “principal plus interest.”

Additionally, traditional financing can carry heavy restrictions and personal risk. To satisfy bank loan requirements, a business is usually required to put up a mix of collateral, including cash and hard assets such as property or equipment. Since the recession, banks are more likely to ask for a personal guarantee from manufacturers who have orders but few, if any, tangible assets to offer as security. If you can’t pay back your loan, you risk losing valuable business assets – and personal ones, too.

The bottom line is that when all the fees, penalties, and risk are added up, traditional financing is not necessarily the most inexpensive or worry-free option. In this changing economy, it’s important for small and mid-sized manufacturers and finance executives to examine innovative alternatives that in many cases are cheaper than traditional financing, and that carry fewer restrictions.

There’s nothing left to squeeze
The financial crisis has forced many companies to take drastic steps to squeeze money out of their internal operations, all to avoid the expense and restrictions of external financing. Companies are employing tactics like cutting unnecessary expenditures, negotiating better terms with suppliers, speeding up collections, and streamlining invoicing processes in order to hold onto cash, according to a 2010 survey from CFO magazine. Fifty-eight percent of respondents in that survey considered it likely or very likely that they would hold finance staff more accountable for cash-flow control. One CFO surveyed said he learned a simple lesson from the crisis: “If you don’t have the cash, don’t buy it.” This renewed focus on disciplined cost-containment may even be a good thing, but it has reached its limit for many companies as the economy comes to life and they begin to take on new business. If there’s nothing left to squeeze from internal operations, they’re going to need an external source of financing to fund that growth, and they should look to flexible and affordable alternatives.

Alternatives offer flexibility
A number of innovative financial alternatives have entered the market or grown in popularity in recent years. These financial solutions can free you from many of the constraints of traditional financing. Examples of alternative financing include widespread use of credit card float (e.g., for T&E or other business expenses); directly incentifying earlier payment, using techniques like invoice discounting; taking advantage of Supply Chain Finance opportunities offered by large customers; and the sale or auction of receivables to a third party.

One alternative that has revolutionized receivables-based financing is The Receivables Exchange, where your business can sell receivables in a real-time, online auction. Unlike other forms of receivables financing, The Receivables Exchange allows you to sell invoices to multiple institutional investors, so you get the most competitive pricing. (On average, businesses get 99-98 cents on the dollar.) There are no personal guarantees, all-asset liens, contracts, or hidden costs, and there is no obligation to trade. Your customers are never notified that you are selling their invoices, so you control your customer relationship. You can sell one invoice, or multiple, whenever you need an infusion of cash.

Now more than ever, it’s important to look beyond traditional financing and consider innovative alternatives to fund your business. The Receivables Exchange is a flexible and affordable financial solution for small and mid-sized businesses. Some businesses use it to supplement existing lines of credit, while others use it as their primary source of working capital.

Avoid personal guarantees
Most business owners and finance executives try strenuously to avoid personal guarantees, which are a staple of traditional financing. Commercial finance websites are filled with advice about how to secure financing without a guarantee, and there’s even something called personal guarantee insurance to protect you. If you sign a personal guarantee, not only is your company on the line, but your personal assets are, too. If your business hits a rough patch, you could lose your house, your car, or your savings. Perhaps that’s why a recent paper from Dun & Bradstreet emphasized that personal guarantees should be considered a “last resort” for businesses seeking financing. Unfortunately, many kinds of traditional financing require some form of personal guarantee.

The Receivables Exchange does not, because investors who are bidding for your receivables assess their risk based primarily on the credit rating of your customers, not your rating. If your company sells to large companies with good credit, these investors are willing to assume the risk of purchasing those invoices, knowing your customers are likely to pay their bills. Your business does assume some obligations: If your customers do not pay, you have an obligation to repurchase those invoices. Most owners would rather assume this obligation than risk losing their house or savings because of a personal guarantee.

Diversification reduces risk and lowers costs
In a paper offering financial management tips, Deloitte recently concluded that, “In the long term, CFOs will likely need to develop a new mix of capital to finance their companies.” Relying on a single source of financing is a risky strategy in the changing economy, and business owners and finance executives should spread out their risk by diversifying their financial portfolios. A sharp increase in bank failures serves as a warning to business owners and finance executives that the bank relationship you have relied on today could be unavailable to you, and soon. A diversified portfolio allows you to adapt easily if one of your financial providers disappears, or stops extending credit to your business.

In addition to exposing you to risk, relying on one source can drive up your costs. Many business owners are too busy to shop around for the best rates from traditional lenders, so they take what is offered to them, and are more inclined to agree to restrictions like personal guarantees. They reluctantly accept expensive fees and penalties because they don’t have the time to seek alternatives.

But things are changing, and many businesses are finding alternatives that are flexible, affordable, and easy to use. Alternatives like online receivables financing allow you to diversify your funding in two critical ways: First, if you are supplementing existing financing with receivables financing, you are instantly spreading out your risk by relying on two sources of capital instead of one. Second, because online receivable financing is a market-based approach, it brings multiple potential capital providers together into one marketplace, so if any one provider goes away, the others will be there to bid on your receivables. And, a real-time marketplace also reduces costs, because capital providers are actively competing to purchase your receivables.

Companies in the manufacturing sector are accustomed to adopting innovative methods to optimize inventory, shorten delivery and billing times, and ultimately make business more profitable. To stay competitive, manufacturers must look beyond traditional financing, and discover innovative financing methods that offer flexibility, affordability, and speed.

Nic Perkin is co-founder and president of The Receivables Exchange, an online marketplace for sale and purchase of accounts receivable. The Receivables Exchange allows businesses to access working capital flexibly and affordably, without the constraints of traditional financing.

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