Getting to the Next Level – Purchase Order Financing

You have just received a large sales order for your designs, a great opportunity for you, and you cannot possibly fill it because your small business is low on cash or below water to purchase supplies in order to fill the order.   So what are you going to do?  Consider the hurdles:

  • Purchase the goods you will need from your suppliers, with upfront money you don’t have
  • Get the money you need from a bank, but without a long track record or history of impressive financial statements this may not work
  • Accept not receiving payment from your customer until 30 or 60 days after they received shipment, creating a cash flow gap you can’t manage.

If you turn down the order, you may lose your customer to a competitor and you will lose out on your opportunity to grow the business.  You will have to get creative.

There is a way to remedy this situation and that is through purchase order financing.   Purchase order financing (or funding) looks to the credit worthiness (and good fashion sense) of your customer.  Your creditworthiness or the fact that your business may be underwater is not an issue; your customer’s creditworthiness is.  A purchase order financing company works with your supplier or manufacturer to get your garments produced on time.  It also works with your customers to ensure payment of the invoice.

Here is how it works.  A purchase order loan is a fee-based, short term loan and there is no interest charged.  To see if the loan can be made, the purchase order lender investigates the credit history of your customer.  If the customer has a good, solid track record of paying its bills and has the cash flow to pay for the goods it has ordered, a loan can be made.  But there is some information required on your part.  You must know your costs for the product and the gross margin attributed to that product.  If you have a gross margin of 25% or more, then it is possible to execute a purchase order transaction.  This means that you will have enough room to make a meaningful profit.

If your customer has good credit, the purchase order lender delivers a letter of credit to the manufacturer that guarantees payment for the needed goods.  The factory then makes the products, and a third party verifies that the order is complete.  The factory gets paid and ships the goods off, usually to a third party warehouse.  It is rare that you would take delivery of the goods; they are usually shipped directly to the customer.po_financing_process_800

When the bill is paid, the funds go to the purchase order lender, which subtracts its fee and sends the remaining profits to you.  This fee may amount to 4%.

There may be a hitch to the receivables portion of the transaction.  If you have given the customer payment terms of 60 or 90 days, another type of specialty lender, a factor lender, comes into play to provide immediate payment to the purchase order lender. (See my post dated June 21, 2016). The factor lender buys the outstanding invoice at a discount and then waits and collects the full amount owed later, pocketing a profit in the process.  Meanwhile, the purchase order lender and you get paid immediately.  Thus, with this good news comes the bad, there is another layer of costs involved with factoring but this may be required by the purchaser order lender.

Here is what you do to start the Purchase Order Financing Process.  You provide a valid purchase order with a credit worthy customer and the expertise to  manage the process.  The purchase order lender provides payment to your supplier, allowing your goods to be produced and shipped.  Payment is typically completed through issuing letters of credit and ultimately the payment of the invoice.

Benefits to using a purchase order lender.  While you stand to get 94-97% of the profit (implies a 25% gross margin), you are getting money to help you grow your business. You can use a purchase order lender many times; there is no restriction.  The transaction does not show up on your balance sheet (off balance sheet financing) as a liability, thus working capital is not impaired by this transaction and your total debt to equity ratio is not increased.

Who, other than the fashion industry, use purchase order lending?  Importers, exporters, wholesalers, assemblers, distributors and manufacturers, who are experiencing rapid sales growth, capital constraints, sales volatility, seasonal sales spikes, high development costs, stretched credit, new product launches can take advantage of this type of financing.  Industries that can benefit are electronics, housewares, sporting goods, toys/games, furniture, food products, hardware and industrial goods.

To find a purchase order company you can look at industry information and the yellow pages.  Make sure you check references first.

 

 

 

A Lesson in Factoring

Do you have a lot of money your clients owe you in the form of accounts receivable? Do these invoices take time, like 60 days, to get paid?  Are you in need of cash to finance your next production line?  You are not a good credit and are not able to get a bank loan.  What can you do?

Factoring may be the answer.  Factoring means that you sell your accounts receivable to a factor or third party at a discount to provide funding.  It is a short term solution to your working capital problem.

account-receivable-financing

Here is how it works.  You sell your invoices to a factor at a discount and these invoices act as collateral.  You would typically receive 80% of the invoice value upfront.  You will receive the balance remaining less a factor fee once your client pays the factor.  The fee can be paid in any number of ways, but it usually nets out to be about three to five percent of the invoice value.  Factoring is not a loan and does not show up on your balance sheet.  It is the sale of an asset; therefore, you have no liability here.

To qualify for this factoring, your invoices have to be free and clear of any liens.  This means that no other company has a claim on payments when they come in.  Your customers must also be creditworthy.  Why? –  Because the factor will rely on their good credit and ability to pay the invoice quickly rather than on your credit history.

Learn how the factor deals with your clients during the collection process.  Does he send out dunning notices with an indication that the factor is to be sent the payment?  If the client does not pay your invoice, the factor may ask you to pay back the money he paid you on the invoice plus a fee – – something that is called recourse factoring.

If you decide that you want to seek out a factor, do your comparison shopping by looking at factor fees and the amount of the discount on your total invoices, a deposit or application fee, the advance rate and monthly minimums should also be considered.  Factors will not work with start-ups; you need to have a large amount of accounts receivable for the factor to work with you.  You can find factors in the telephone directory or in industry trade publications. Your banker may be able to refer you to a factor, but decide on a factor that knows your industry, can customize a service package for you, and has the financial resources you need.

Make Customer Service Your Mission

 

Many times in my classes students often confuse a mission statement with the business description.  A mission statement communicates to the world what you as a company stand for.   You have read some of them, like “We aim to be No. 1”, or to “Give back to Society”.  And a business description is one that defines the industry, product and market of the company.  So these are completely different in their scope.

customer_service_2But why not have your mission statement focus on the customer and what you might do for them instead of on you?   As a customer I don’t care about what the company will do but what it will do for me and others in terms of perceived value.  After all, customers are the ones who purchase your products, pay your bills and your salary, and help grow your business from day to day.  So, your company would be nowhere without people to buy your products.  Treating these people extremely well should be the No. 1 goal of every company.  By giving your customers great customer service you will be ahead of the competition.  Give great customer service and your customers will keep coming back and they will tell their friends who tell their friends, and so on.  You will have the benefit of viral marketing, the best kind of marketing you can have.

But, how do you communicate to your employees and the world what your mission is with regard to customer service?  Here are a few tips:

Write down the mission statement of your company and include a customer service component.

  1. Make it real.  Put in place systems that help, instead of hinder, customer service.  Give the employees the tools to make it happen.  For example, make a system to make sure that orders are taken accurately; instill in your employees the bottom-line value of giving good customer service.  Work should end up being easier because of good customer service.
  2. Respect customer service.   We need to see that customer service is an honorable profession.  Respecting the importance of servicing others – whether it is your suppliers, your co-workers, or the mother buying your baby food online – is key to giving great service.
  3. Define what you mean by customer service and then measure the results.  Spell it out in clear, definitive terms what you mean by customer service.  It is not enough to say “The customer is always right”, what does that really mean?

Here are three steps to great customer service:

  1. Figure out what the customers want.
  2. Get it for them accurately, politely, and enthusiastically.
  3. Go the extra mile for the customer.

After you have defined excellent customer service, measure the results to see if it is working and reward the people who give great service.  Keep track of the number of returns, incorrect fulfillment, customer complaints, repeat orders, repeat customers and customer referrals.   Watching service performance scores can predict whether you will have problems in the future.

 

What do Venture Capitalists and Angels Have in Common?

Have you often wondered what the difference is between an Angel investor and a Venture Capitalist?  There really isn’t much difference except for the size of the investment in your business.

Angels are private investors who are looking for a better investment and return than traditional investment schemes, like in the stock or bond markets.  The age of the company and other specifics are on their checklist: early or formation stage and they look for a payback and a return on their investment where revenues are between $2 million and $10 million.  They would usually expect preferred stock in return for their money which would pay semi-annual interest for the use of their money.  After 5 to 7 years they would expect to be paid back and exit.

Venture Capitalists are on a higher plain than Angels and can be private equity funds or hedge funds.  They invest in early stage companies expecting a high return for the high risk involved where revenues are in excess of $10 million.  Venture Capitalists look for companies with a defensible market position, strong management team, positive EBITDA and discernible growth characteristics.

So what do these Angels and Venture Capitalists look for, you may ask?  Think about the program Shark Tank seen on ABC-TV.  You may have seen Angel investor Kevin O’Leary quizzing the presenting owners of small companies.  He asks, “How am I going to increase my investment?”  “What are your goals for the business?”  “I don’t like your valuation!” “What are your margins?”  “What are your sales and in what time period did these sales occur?”

What is making him salivate or not over the company’s products?  These attractions are not unlike what the Venture Capitalist looks for.  Take a look at the following:

  1. Unique or proprietary products or services.  A patent owned by you is a plus.
  2. Existing sales are evidence of consumer demand where revenue growth is greater than 20% to 50% year to year; gross margins are over 40%; and with a lean management team.
  3. Increasing sales would be the result of their investment by marketing or hiring additional personnel, which they will oversee.
  4. Realistic valuation based on your sales and profits
  5. Exit strategy must be included in your plans, like selling the company or merging with another company.

While some of you may say that seeking funding from these people is not worth it.  Think about this.  If you did not have their investment you would not be able to grow your business faster, gain market share and have the benefit of their expert opinion and management expertise.  Their contacts and relationships would help you gain clients and suppliers for increased revenue and growth.  So it is worth it, but make sure that you benefit from the relationship as much as the investor would.  It is a two way street — the investor is making money on his investment, and you are gaining a person who can direct you in your business with his expertise, open doors to business partners and add to the valuation of your business.