Most companies assume that having high inventory turns is a good thing. After all, it means the company is able to reduce the time it takes to hold inventory. It means the company is making sales and that its customer base has a high demand for the company's product offering. High inventory turns means a company can reduce its costs of financing, its costs of warehousing, its costs of product obsolescence, its costs of damage and pilferage, and finally, it means the company is maximizing its warehousing space by properly scheduling incoming and outgoing shipments of finished goods. However, how does a company support its fast moving inventory if it has an uneven cash position? How can a company make sure that it's able to finance its inventory, pay its suppliers, and keep product on the shelf, if it's having problems with cash flow? Well, when companies need to support their quick inventory turns, many of them turn to receivables factoring in order to keep their inventory moving and their customers buying. So how can receivables factoring help companies maximize their inventory turnover rates? More about Asset Based Lenders
Understanding Inventory & Warehouse Management Costs
Companies are always striving to reduce the amount of time inventory is stored within their warehouse. For some companies it involves using multiple contracts and supply agreements, ones where vendors retain inventory on behalf of the company in order to reduce the costs of warehousing and storage. For other companies it involves focusing on increasing inventory turns by increasing sales and growing market share. Still, for other enterprises it's about immediately liquidating outdated and slow moving inventory by using discounts, price reductions and inventory liquidations. It's all about reducing the time inventory is held within the warehouse by using a multipronged approach of supply contracts, high volumes sales and inventory liquidations. However, none of this is possible if your company doesn't maintain a strong cash position. In essence, in order to capitalize on high inventory turns, your company must be able to improve its cash flow.
Avoiding the High Costs of Inventory Stock Outs
You need a strong cash position to support a high inventory turnover rate. Receivables factoring can help by making sure your vendors and creditors are paid on time. Its purpose is simple: Receivables factoring helps your company avoid the high costs of inventory stock outs and finished good shortages. After all, if your company doesn't have product available to sell to its customers, then it's natural that your customers will go to your competition. In this case, an out-of-stock (OOS) situation ultimately leads to losing business, losing profit, losing customers and eventually losing an important share of your market. This is why maintaining the right amount of inventory is essential to securing your position with your customers. When it comes to inventory, companies must realize that there are costs of having product in a warehouse, and there are costs of not closing business because of insufficient inventory counts.
Supporting Your Vendor Base
So how does receivable factoring help cash flow and improve how your company finances and supports its inventory? First, it allows your company to use its receivables as credit. A financing company will buy your company's receivables. In return, your enterprise will receive an advance of capital based on a percentage of the receivable's total value. Your company can set up a rolling credit line, one where each new receivable is used to secure working capital. Second, it reduces the costs of capital by reducing your company's costs of financing receivables. Instead of waiting on customers to clear their outstanding balances, your company is able to use its receivables as an asset-based financing option. Third, receivables factoring reduces your priceing for raw materials and finished goods by empowering you to negotiate early payment discounts with vendors and creditors. In essence, your company is reducing your vendors' and creditors' costs of capital by paying early. Early payment reduces their financing and improves their cash flow. As such, your vendors should reward your company for prepaying.
How Does Receivables Factoring Work?
Factoring is one of several asset-based financing solutions. It allows companies to use the liquidity of open customer invoices in order to set up a business line of credit. These invoices are essentially sold to a financing company, which then advances the business capital based on the value of the receivable, its age and the customer who owes on the invoice. In fact, your company's credit rating and history are of no concern to the financing company. It advances funds based on the credit rating and payment performance of your customer. Once your customer pays the financing company on the invoice, your credit line is reimbursed the difference between the initial advance and the final customer payment. A transaction fee is then applied for the financing company's services.
What Type of Industries Use Receivables Factoring?
Contrary to what some companies believe, receivables factoring is an asset-based financing solution that goes back thousands of years. Most associate factoring with the construction industry, one where companies must finance construction projects months in advance of generating any revenue. It has also helped thousands of companies in the garment and textile industries, in addition to helping manufacturers and freight forwarding companies finance their operations. However, today's factoring companies support multiple industries. In essence, this asset-based financing option can be used by any company, in any industry and with any customer base.
Perhaps the best example of how factoring helps with inventory management is to reflect upon how small distributors, wholesalers and retailers must support their customer base. A number of these smaller enterprises are forced to prepay their vendors for products. Lack of cash can inhibit a distributor's ability to pursue large volume contracts with their own customers. In fact, an enterprise could have a fantastic product offering, solid gross profit on sales and yet still not be able to close the business. In the worst cases, these smaller enterprises must abandon some opportunities simply because they lack the capital to support their inventory. However, factoring allows these smaller enterprises to pursue all opportunities, regardless of their scope, their size or their capital requirements. They can then schedule incoming deliveries from vendors by prepaying their orders.
A common mistake is to assume that receivables factoring is a loan. Many enterprises ignore factoring because they feel they lack the credit rating and history to secure this type of financing. However, as previously mentioned, the factoring company never bases its decision to advance a company money based on its credit history. These financing companies are primarily concerned with the company's end-user customer. In this case, factoring acts like a loan but will not appear on a company's balance sheet. It is an ideal financing option for companies that are reluctant to provide financials, and or companies that have less than stellar credit ratings.
Banks, credit unions and conventional financing companies base their decisions to lend on a company's financial position. These credit sources require that companies provide a history of performance. Typically, this means providing all three financial statements and demonstrating consistent returns over a four to five year period. These requirements have become even more stringent since the most recent global recession, one where creditors are reluctant to provide credit to small and medium sized enterprises.
Simply put, today's enterprises must protect themselves against the effects of out-of-stock situations. They must ensure they have the inventory ready in order to win business. Most importantly, they must not allow a lack of capital to inhibit their plans for growth. As such, factoring is an ideal solution for those enterprises that must provide time critical shipments of finished goods, and ones who require a solid source of credit with which to support their high inventory turnover rates.
- Bank Financing: With bank financing, a company must pay interest rates on the amount of capital they borrow. First, companies use borrowed funds to purchase inventory. This is the first financing cost that companies must cover. Second, once that inventory is sold, the company must then finance its receivables. Therefore, there is a cost of money to purchase inventory, and hold that inventory, and there is a cost of money for the company to wait for its customers to pay. This is why conventional financing is measured by the company's daily cost of capital. This daily capital cost is present for every day the company holds inventory and every day it waits for its customers to pay. How is factoring different?
- Receivables Factoring: With factoring, a company doesn't have to finance its inventory over an extended period of time before making a sale. It also doesn't have to finance its receivables and become an inexpensive credit source for its customers. Instead, factoring empowers companies to reduce their costs of capital by improving their cash position. A stronger cash position means the company can reduce costs with vendors with price reductions and invoice discounts for prepayment.
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