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.

How to Accelerate Cash in Your Business

As you manage your business from day-to-day you need liquidity, that is, cash.  Cash is required to pay your bills from suppliers to your utilities bills and even your employees.  So, where is this steady flow of cash coming from?  Your customers!  How do you increase your cash balances in your business? Let’s investigate the Operating Cycle and the steps that are involved in the conversion process.

In order to understand how to accelerate the cash conversion process is it important for you to understand your Operating Cycle.  That is the amount of time it takes for you to convert cash to inventory to sales to accounts receivable to collections to cash again.

In any business, you begin it with cash as you can see below.  You determine how to spend it whether it is on  furniture and equipment or your raw materials. As your raw materials are converted into product you start building inventory. As your sales people become involved and start selling, your billing department bills and your accounts receivable balances increase. Depending upon the way your customers pay their bills, you may receive your money anywhere from 45 to 60 days. Then it is deposited in your checking account and the process starts all over again. At each stage of the Operating Cycle there is an opportunity to shorten cycle times.Operating Cycle Chart

Strategies to Improve Your Operating Cycle

 Your accounts receivable levels are important to watch.  Bills are usually collected on a 45 day basis.  Some customers may even pay sooner than that.  Those customers are gold. Others are not.

You should indicate clearly on your invoices what the terms of payment are.  These are usually 10/20 net 30, meaning that if the bill is paid within 20 days, then the customer is entitled to take a 10% discount on the amount due.  You benefit by collecting on that invoice sooner rather than later and having the money to run your business.

But consider the customer who pays in 60 days.  This customer is costing you money!  You are actually financing this customer to the tune of 36% a year.  That is an incredible financing charge.  Did you ever realize that you were becoming a bank by not collecting on these invoices?  Therefore, it is critical to your cash flow to collect the amounts due you promptly.  Hence, the time value of money:  a dollar today is worth more than a dollar tomorrow.

Consider the following actions to take:

  • Have your available cash reported to you daily and chart it against weekly Accounts Receivable and Accounts Payable Reports. These reports will indicate how long your invoices are outstanding and which ones to watch closely for delinquency.  Your current ratio will be improved with monitoring and you will understand your business better.
  • Get your bills out more quickly. Bill as soon as the shipment is sent out. Hire a person to do nothing but make sure invoicing is timely and follow up on payments.  Send out friendly reminders at least 5 days before the deadline that payments are due.
  • Follow-up calls to customers are important to remind them that the invoice is due. These calls will also reveal whether the order is received in good order and if the customer is happy with the shipment.  Sometimes a customer will not pay on an order that is unsatisfactory because he is a small business and he is just too busy to make that phone call to you; he just holds the goods instead of returning them to you.
  • Understand each customer’s payment cycle, and time your billings to coincide. Offer credit card payment, leasing options to make payment easier for them.
  • If a customer is strapped for cash and cannot pay the total amount of the invoice, then you must ask him to pay something right away. Making an installment plan with him is beneficial to you and to him.  You must collect something in order to make it easier for you to meet your cash demands, and he has just reduced the amount outstanding on that bill.
  • Shorten cycles for delivery of your product. Work-in-progress times should be shortened for faster completion of projects, and the faster your will get paid.

 

Are Some of Your Customers Late Payers?

Having some of your customers pay late can cause you a lot of “hand-wringing”.  You can’t pay your own bills on time.  You ask yourself should you ask for a line of credit from a bank in order to pay your own bills.  It is a constant struggle for small businesses to get paid on time.  In fact, 64% of small businesses are paid late.

What are you going to do to alleviate this problem?  Charging a late fee could help late payers get up to date.  Are you reluctant to do that for fear of creating ill will with your customers?

But not charging a late fee would be a mistake, especially for chronic late payers.  Businesses have to realize that they need good paying customers if they want to make money.  Remember my earlier post, on January 13, 2016, about Sam Walton saying “if you want to make money collect on every invoice”.  Also, you could be financing your customer’s business to the tune of 36% a year.  Why do this, you’re not his partner!

If you decide to charge a late fee you should have a policy in place or even a contract with the client which would include your late-fee policy.Sample_bill  You can’t decide to charge a late-fee after the fact if it wasn’t in your initial agreement.  Your invoice should include a statement at the bottom of the page which indicates that late payments will incur a charge of 1.5% per month, for example.

Even if you don’t charge it, it can work well as an incentive to get people to pay.  Upon receiving an invoice which includes a late fee your customer may give you a call to settle the bill, or even negotiate the rate of late-fee charged downward in a new contract in lieu of other charges that may arise during the project.

Small businesses must be clear on their policies up front and implement a communication strategy to collect so they’re in contact with customers promptly if they are late on payment.  Even is they are late one day, you should be on the phone with them to tell them that you haven’t received payment as yet and when can you expect to receive it.  You can then gauge the customer’s response for sincerity when you do reach out.

It’s Spring and Its Tax Time

 

adding machine

As small business owners we have to be mindful of the fact that we have to prepare our taxes on the business as well our personal filings. As budding entrepreneurs we may not realize that there is a fair chance that we could create tax headaches for ourselves.  Since we went into business we may have more forms to fill out that are growing more complex as time goes by because of new laws coming into play in the federal and state tax codes.  And it can become difficult to keep abreast of the changes that affect us.

Just think about it. If we have employees we have to consider the new withholding taxes and the sheer volume of work that is involved. And it is not just the work; employees will need explanations as to why their pay stub is different. The employer must file federal tax Forms 941, Employer’s Quarterly Federal Tax Return, and 940, Employer’s Federal Unemployment Tax Return (FUTA), which address reporting of withholding for social security, Medicare and unemployment, as well as for federal and state income taxes.  So it is difficult for the small business owner to keep up with all this information and the changes in the withholding tax laws and rates.

With regard to the business itself, Schedule C, Profit or Loss from Business (sole proprietorship), revealing the sales and expenses of the business, must be completed. Some issues may come up in preparing these; for example, any change in the value of inventories must be calculated and the treatment for the related profits and losses must be addressed. The treatment for such changes can be a tricky situation for the entrepreneur.

If you have an online business and sell to customers out of state, there is another issue which can become problematic. Some states which are short of cash may force companies to collect tax on sales made to their residents even when the company is based elsewhere.  Court challenges on this topic leave the requirement in doubt, but if the trend catches on companies would find it harder to comply with the various sets of rules and tax rates.

What is the entrepreneur to do? In the first place it is recommended that a payroll preparation company that serves small businesses be hired to prepare your payroll and file the required withholding taxes and quarterly reports for your business.They are not expensive and the time and energy they can save you makes this task worry-free.

Hiring a small business accountant who has experience in your type of business is also worthwhile. Make sure you interview them for their abilities and your needs. While the fees they charge are an important consideration, you may want to retain them instead of getting billed for every question you may have. An accounting firm should have a retainer, like $150 a month, to cover payroll, tax returns and other filings. In this way you will be able to develop a relationship with the accountant and someone you can lean on.  Nickel and dime billings for phone conversations would be nonexistent.

An experienced small business accountant who understands your business can help you grow your business.  If he is asking the right questions he would address your goals and where you want to be in the next couple of years. He can help you shape your life.

Keeping Your Eyes on the Books

In teaching Entrepreneurship I often tell my students that they should at least understand the accounting and bookkeeping practices involved in their businesses.  They should be able to speak the language of their accountant or bookkeeper and be able to ask for periodic reports to enable them to review their business’ financial position at any point in time.  The several accounts to be mindful of are the following: 

Cash.  All of the transactions your business has pass through the cash account whether it is for the receipt of collections or the payment of bills.  Some bookkeepers use two journals – cash receipts and cash disbursements – to track activity.

Accounts receivable.  If you are a manufacturer or a service provider and you don’t collect payment immediately, you will generate “receivables”, and you must track them by having your bookkeeper generate an aged receivables report indicating which customers owe you money and how long the bill is outstanding. An effort to collect “old” bills is required to get your money.  Busy businesses generate an accounts receivable report daily.  But it is up to you how often you would want to see this report.  But you should review this report weekly for any potential problem accounts.

Inventory.  Products you have in stock to sell are your “investment” sitting on the shelf and must be carefully accounted for and tracked.  Periodic audits of what you have on the shelves and what you have in your books must be compared and verified.  It is important for you to determine what level of inventory is needed in order to satisfy your customers’ demand to avoid any write-downs of obsolete or damaged inventory.  An analysis of these accounts will help to determine this level.

Accounts payable.  No one likes to pay bills and send money out of the business, but if you have good bookkeeping practices you will have a clear picture of everything if you use your accounts payable feature on your bookkeeping software.  You will have timely payments, and you will not pay anyone twice.  Paying bills early may qualify you for discounts with your vendors.

Purchases.  The purchases account is where you track any raw materials or finished goods you buy for your business.  These work- in- process accounts are part of your inventory account, and they can help you calculate your cost of goods sold, which is subtracted from your sales to find your company’s gross profit. Here you will be able to see if you are paying more for your raw materials and take measures to reduce the costs of them and improve your profit margin.

Payroll expenses.  One of the largest expenses for all companies is the cost of paying employees.  Keep this account up to date for meeting tax and other government reporting requirements.

It is important to note if you cannot hire a bookkeeper that you purchase a good bookkeeping software package, like QuickBooks, to help you organize and track your sales, collections and inventory.

Getting Your Collections on Time

Sam Walton, the founder and owner of Walmart, was once asked how he became so successful.  He responded that to be successful you must collect on every single invoice that you send.  Otherwise, you are losing money and financing your customer’s business.

There are several clues that you should pay attention to when your collections are not being paid on time or even late:

Sudden change in payments.  If a customer, whom you have had for years and who always pays on time, suddenly stops paying on schedule, it could mean an early indicator of financial problem. Sudden partial payments from a customer who used to pay the full amount may also point to a problem.  He may even avoid your phone calls or ignore your emails is another red flag.

New dispute over old invoices. A customer who suddenly complains about quality issues with goods or services received or performed a while ago could be another early warning sign.  They may complain about the quantity delivered or the order was not delivered on time.

Broken promises of payment. When  customers are contacted about the late payments or not being paid at all, they my offer many excuses, like “The check is in the mail,” “The accounts payable clerk is on vacation,”or “We forgot to mail it.”  These empty excuses are indicative of a cash crunch.

When a check bounces.  If you have a relationship with a customer whom you both need you may relax your acceptance of promises with him.  But when a check bounces, and you need that money to run your operation, it is no forgiven acceptance.  Will you continue to accept checks from that customer?  You will have to do business on a cash only basis.

Change in the size of the order.  If a customer orders an unusually large order not in line with its normal order size, it could mean that he is stocking up on you because he cannot get credit.  Or, it could be a smaller than usual order meaning that the customer does not have to funds to pay.

What should you do as a business owner in the event one of the warning signs comes to fruition?  Well, certainly you should be in close contact with your customers.  Keep that good relationship going.  If a customer who has a good business dealing with you suddenly has a situation which is temporary, you want to have that open dialogue to let them know you are aware of the situation.

If you start to see that your bills due within 30 days of receipt are slowing up, don’t wait to call the customer.  Do it on the 31st day.  Remember: The older an invoice gets, the harder it is to collect.

Good business practice is that you should collect the customers banking information and credit card information at the start of a business relationship.  Having a written contract with him reaffirms that there is a business relationship.  Develop a policy with your accounts receivable people to determine when past due collections should go to a collection agency.