How to hurdle fast growth financing without adding debt to your business?
8-28-2006
Debt Financing or Off Balance Sheet Financing?
In this article, we will discuss two types of financing: Debt Financing
and Off Balance Sheet Financing.
Debt Financing describes a traditional or conventional loan issued to a
business that creates a liability on the balance sheet. Due to the
nature of this type of financing, it affects debt-to-income ratios that
are usually considered when applying for future loans or gaining access
to capital.
Off-Balance Sheet Financing has no affect (as the title implies) on the
Balance Sheet. There are two types:
Equipment Leasing and
Factoring.
Equipment Leasing allows a business to buy equipment with rental
payments, and the balance sheet is not affected with debt-to-income
ratios that may defer future access to capital. (You may want to ask
your accountant if Equipment Leasing is the right choice for your
business). The key point is this: There is no reason to tie up your
working capital when you can rent to own the equipment. Even if the cost
of the funds is higher than a traditional loan, the rent payment to the
leasing company is 100% tax deductible, and sometimes, that alone may
offset some of the additional cost.
Another type of Off-Balance Sheet Financing is “Factoring” (Accounts
Receivable Financing). Factoring is the purchase of a company’s accounts
receivable. The factoring company converts the accounts receivable to
cash and leaves the business with cash on hand and no receivables.
Factoring is not a loan, so there is nothing to pay back. See Factoring
(below) for more information on how it works.
Who uses Factoring? Business owners who face exponential growth can find
themselves short of the cash they need to meet everyday operating
expenses. Many business owners (during their first financing stage)
never anticipate accelerated growth. Small businesses can access capital
by tapping into a personal savings account, using credit cards or taking
out a home equity loan but they may fall short of cash when uneven sales
patterns occur.
Fluctuating sales can interrupt the working capital needed for supplies,
rent, payroll and routine expenses. This is a common scenario that is
usually not anticipated in the financial planning of the business. When
business growth outpaces working capital, few options are available.
Business owners, who frantically seek financing, normally go to the most
obvious source: Banks (that offer Debt Financing). They may hit a brick
wall after they visit 20 banks and realize that the maximum amount of
their loan can only match the collateral that their business has to
offer. Most start-up businesses do not have enough assets or equity to
meet the loan requirements. In addition, conventional loans are very
slow in processing and may not be approved in time to meet current
obligations.
Factoring (Off-Balance Sheet Financing) is available for fast growing
businesses that offer credit terms to their customers or commercial
accounts. It is the easiest and most flexible type of financing
available. It involves establishing a credit line by advancing money to
a business by pledging its accounts receivable as collateral. The
invoice created by the business (for services or products accepted by a
customer) is considered (by the factoring company offering funding) to
be a realized asset.
How does it work?
A business issues an invoice (receivable) to its customer. The factoring
company purchases the receivable (from the business) at a discount. The
factoring company then transfers funds to the business and mails the
original invoice to the customer. Then the factoring company waits to
get paid. It is that simple! The process to set up takes about 5 to 7
working days and the business owners do not need good credit scores for
approval. Factoring companies rely mainly on the credit worthiness of
the customer because the invoice for delivered product or service is the
collateral used to fund, not your credit score or financial statements.
How much does factoring cost?
Factoring companies charge discount fees based on the value of the
invoice. If your business accepts credit cards, then you are already
factoring to a degree. For example, your credit card merchant charges
you a discount fee of 3% and you receive 97%. A factoring company works
almost the same way but the advance and discount fees may vary depending
on volume and industry.
US and Canada Tel 1 800 450 9653 United Kingdom Tel 0 800 404 9669
1st Commercial
Credit, a
nationwide
factoring company headquartered in El Paso, Texas. Provides accounts
receivable financing in the US, Canada, and the UK; offers
export trade finance to clients in every major world
market and can convert receivable finance transactions in 17
currencies.
1st Commercial Credit is a
factoring company that provides receivable financing for all major industries, We are
always adding industries to our portfolio.
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