You may have crucial production and sales calls on line one and two, but be careful not to press the hold button when it comes to paying attention to your financial strategy.
“It is important to remember that firms are in business to make money, not products,” cautioned Omar Espinoza and Robert Smith in their recent e-book, Business Management Practices for Small to Medium-Sized Forest Products Firms. “Understanding and managing the company’s financial resources is one of the most important activities of the business owner, and it often does not receive adequate attention.”
So What Are the Preferred Sources of Capital for Small and Mid-Size Businesses?
A recent study, Access to Capital: How Small and Mid-Size Businesses Are Funding Their Future, outlines the trends for these business categories. And in case you are wondering where your company is positioned in terms of size, the report classifies annual sales of less than $10 million as small business, and greater than $10 million as mid-size. The Small Business Administration (SBA) classifies companies with less than 500 employees as small businesses.
Not surprisingly, the study reports that self-financing through cash on hand is the preferred choice for funding, followed by debt (including a clear preference for bank debt) with all other options finishing a distant third place. Aside from the cost of borrowing money, the key considerations for borrowers include access to financing, speed and certainty of a loan, along with a positive relationship with the lender.
According to a recent article in Forbes titled “The Small Business Financing Pie: Who Has the Biggest Piece?”, small businesses receive loans amounting to $700 billion annually from banks. The next most popular form of credit is through credit cards, at $336 billion, accounts receivable factoring at $15 billion, and alternate forms of credit such as marketplace lending, at 10 billion. The latter two are growing fast.
Pay Attention to Your Credit Worthiness
Your banking strategy should be to maintain a solid personal credit history before you get into business and beyond. Establish this through paying bills in a timely fashion and lowering overall debt. Also, avoid applying for credit too often. When it comes time to apply for a business loan or lease, the personal credit of business principals will be checked during the evaluation process. In order to understand your credit score, you can access a free report from major credit bureaus, including Equifax, TransUnion and Experian. If your credit score is low, it might be prudent to focus on improving creditworthiness before applying.
Another important consideration is to check their Dun & Bradstreet (D&B) report. D&B evaluates a company’s creditworthiness from vendor payment information, public information and financial reports. Oftentimes, small business owners can make the mistake of not taking the time to respond to D&B inquiries, thinking of them as just another sales call. Don’t dust them off, cautioned Catherine and Greg Weis of Gem Leasing, a firm that has been working with the pallet and pallet equipment industry for over 20 years. Greg stressed that hard working pallet business people may not realize the impact that D&B ratings can have. “These reports are often erroneous for small businesses, and can have a negative impact,” he warned.
Banks and Credit Cards Still Lead the Way
Experts are reporting a shift from larger to smaller banks for small business lending, and from banks to alternative sources of financing. The sobering statistic for small business operators is that less than 22% of loan applications from this category are approved by big banks (those banks having assets of $10 billion or more), and only half of small business loans are approved by smaller banks. Also noteworthy, just 5% of small and mid-size companies have utilized U.S. SBA loans during the last three years, even though these come with a government guarantee to the lender, which translates into less risk and a more attractive interest rate. Respondents from the Access to Capital study blamed too many obstacles such as bureaucratic processes and lack of awareness, as well as burdensome requirements and terms.
Credit cards have become a convenient second choice for small business financing, which is not surprising given ease of availability and convenience. Forbes noted that while credit cards get a bad wrap, they are “cheaper than most alternative lenders, which makes them attractive to small businesses. Their average interest rate is 15%, while most alternative lenders charge 20-80%.”
Factoring to Improve Short Term Cash Flow: Lower Rates and More Cooperative Approach
Increasingly popular, factoring is another option for keeping ahead of cash flow issues. It is an approach that companies can use to meet immediate cash requirements while avoiding debt, one which involves the sale of account receivables for a discounted amount. This can be a useful approach for new companies that do not have established credit, as long as their customers are solid, and as well for growing companies experiencing a cash crunch. There are several companies which offer this service, however the cost of this tactic, versus conventional bank debt, has dampened interest from prospective clients. The service is transforming, however, as providers come to the table with lower rates and with a more “hands off” approach to collecting payment, which factoring clients appreciate.
What people may not know, said Skylar Lane, vice president of business development at Triumph Business Capital, is that rates have become increasingly attractive. For example, for mid-sized companies, he reported, the fee would be somewhere between 1.5 to 2%, net 30 days. Invoices outstanding after 30 days are billed at a daily rate of $0.05 to $0.07. Triumph’s approach is to work with a client to analyze its customer list and perform a public record search. The client can decide which of its customers to include in a factoring arrangement. Once agreed upon, the client has access to fast payment. “The day they invoice, we will send the funds,” he commented.
Lane cautioned that some boutique factoring firms charge higher rates or hidden fees. “They may have maintenance or administrative charges, or funding fees. These are really common to our industry. We have only one fee and that is it.” One area that some people considering factoring have expressed concern with respect to late payment is follow up. They are concerned about 3rd parties possibly hassling a valued customer for a late payment. Lane said that his company is sensitive to such scenarios, and is flexible to how those situations are handled.
The Emergence of Online or Marketplace Lending
As large banks increasingly abandon the small business market, an emerging group of lenders has aggressively targeted this space, according to reports in publications such as The Wall Street Journal, which in October ran a headline entitled “Online Lenders Deluge Small Business.” With billions of dollars available and aggressive sales strategies, small businesses report feeling themselves overwhelmed by competition for their business – which should in theory be a good thing. Such lenders will provide an estimated $7.9 billion in small-business loans in 2015, a jump of 68% from last year. Still only amounting to 3.3% of small business loans, Morgan Stanley believes the share could hit 16% by 2020.
There is a lot to like about the new offerings, pioneered by companies like OnDeck Capital and Kabbage Inc. In terms of speed of approval and simplicity they can be very attractive – but then the catch – they also carry some hefty interest rates, reportedly as high as 40-50% annually. With much higher interest rates than bank loans, they should therefore be scrutinized with extreme caution. Rates are expected to improve, with some lines of credit now reportedly in the 20% range, so may be worth revisiting in the future. With this in mind, another option to consider to cover short term cash flow is invoice factoring.
Equipment Leasing: Choose a Specialist
If you are thinking about leasing equipment to keep your line of credit intact for operations, conserve capital, as well as other benefits, you are not alone. Over 80% of American companies lease equipment. Other benefits of leasing include the ability to roll soft costs such as installation into the lease, flexible terms and minimal down payment, not to mention potential tax benefits. Additionally, banks are generally more reluctant to loan money on depreciating assets such as equipment, and they are less likely to understand the prospects for liquidating the equipment if the borrower defaults.
Instead of just going to the bank for equipment purchases, this is where an experienced industry equipment lease provider can add value. One interesting sidebar, Gem Leasing says that in its 20 years of service it has never actually had a lease default. Usually if a customer falls behind, they can work with them through difficult periods. In the long run, Greg Weis stated, this is an approach that is ultimately positive for leasing provider and pallet company alike.
A key piece of advice from Catherine Weis is to go with a provider recommended either by the equipment provider or by other pallet companies. It is very important to go with a leasing company that knows the industry. Also, Greg cautioned, while it is important to compare prices, be sure not to shoot yourself in the foot by applying to several leasing companies. He noted that if too many leasing companies pull your credit status, this can negatively impact your creditworthiness. And for leasing as well as for bank loans, one of the first points to be considered by a provider is your personal credit history.
In summary, if you haven’t checked your personal and company credit recently, now is the time. Regardless of whether you are currently looking for money, take the necessary steps to improve your score, if needed. As banks become increasingly reluctant to provide loans to small business, leasing companies will continue to be an important means for operators to renew and grow their businesses. And finally, efforts to improve the cash cycle through approaches such as focusing on invoice management (see sidebar) can be beneficial, and while other tactics such as invoice factoring may prove useful to some.
Proper Invoicing Methods Improve Cash Flow
It can be easy to ignore invoicing with everything you have to do on a daily basis. But proper invoicing procedures can affect cash flow and a company’s ability to grow. These tips can help you get paid faster.
1.) Setup a Well Designed Invoicing System – Treating invoices like a necessary evil means they get ignored instead of designing them for maximum impact. For example, a simpler invoice is less likely to be set aside for further examination with other complex billing situations.
2.) Clarity Leads to Faster Processing – The terms should be clearly explained so that nobody has to guess when payment is due or the consequences for not paying on time. Accuracy also improves the speed of payment. Make sure your invoices are right the first time.
3.) Accuracy Helps Expedite Payment – When an invoice is not accurate, or to put yourself in the shoes of the customer, does not resonate with what the customer believes he has agreed to, then a payment delay can be anticipated.
4.) Invoice Promptly – The faster you issue invoices, the sooner your customer gets the bill, which should speed up receivables. One way to do this efficiently is with an automated invoicing system, especially if you send out a lot of bills. Timely receipt of payables is enhanced by prompt issuance of invoices after the goods have been shipped or services performed.
