Working Capital (cont’)
On the previous page I talked about Overdrafts and Debtor Financing as some ways to finance your working capital. The next few topics are Stock Lending, Purchase Order financing and Contract Finance.
Stock Lending is the holy grail for business owners.The amount of requests I see for this type of lending is astounding. What most people want is a way for them to continue to buy their stock and finance it until it’s sold within the normal operating cycle.I’ll show you how you can do this in a moment.For now I’m going to talk about Stock Lending for opportunity.
There are a couple of types of businesses that will be best suited to the stock lending that is in the market-place right now. The first one is a business that has very, very high gross margins. An example might be a business that sells a product at shopping centres after importing them from a country with cheaper manufacturing costs than Australia. I don’t know, let’s say a sunglass importer that buys product from China at $4 and sells their product for $22.
The reason Stock Lending suits them is due to their high margin and high turnover. Stock lending can be considered expensive and as such you need to have a good profit in the initial purchase as well as the ability to turn it over quickly. Sure, it might cost you around 5% of the purchase price to have the lending, but at such a high margin, its the price you pay for being able to finance it in the first place.
The second business that would use this lending is one that sees an opportunity that doesn’t normally present itself. For example, you might be running a small supermarket or retail outlet. You are given the opportunity to buy a particular product at a very discounted price and you know you can turn it over quickly. Perhaps another retailer has gone out of business or your suppliers have excess stock. Either way, you can buy the product very cheaply and sell it at a discount to clear it quickly.
In both the instances, the common denominator is a high gross margin. The Stock Lender needs to know that if they provide the finance to buy this product and you fail as a company, then they can still liquidate it and get their money back.
The process of stock lending is usually that the Stock Lender will actually buy the product in their own name and then re-sell it to you at a higher price which reflects their charges. It sounds convoluted, but it takes care of risks regarding ownership of stock should something go wrong.
Now, if you are a business that is growing and you are receiving larger orders for products but don’t have the resources to finance them, then Purchase Order funding is for you.
Purchase Order Finance helps when you receive orders that are larger than your current resources can handle. Let’s say that you are a company that makes a type of device like medical instruments. For some time you have been wanting to tender for larger orders and suddenly you win one.
Now you have to quickly increase your staff, order more stock and use more resources to produce the equipment for your customer. Your customer will provide you with a purchase order, but it will take about 60 – 90 days to produce the whole order and they don’t pay for at least another 60 days.
Purchase Order financiers usually work hand in hand with Debtor Finance. In fact they will often have their own Debtor Finance facilities.
You will need to provide them with your cash flow forecasts and historical financials to show you at least have some financial capacity. They will need to see a copy of the Purchase Order and confirm the process for sign off that the order has been completed.
Purchase Order financing particularly suits a situation when you are making and delivering a product only. If you are constructing something and installing it (ie. there is a labour charge) then you might not be approved for this finance. This is because it is often too hard to determine when the transaction is finished and the Purchase Order financier cannot re-sell labour to someone else.
With this type of finance, you might find that the funder will pay your suppliers directly for the product rather than provide you with all of the money available. This ensures that the funds are used for exactly the purpose they are meant for.
Once the purchase order is completed by the delivery of the goods, then the financier will probably swap you to Debtor Finance. They will use your invoice to draw down against, payout your Purchase Order finance and then when your client pays your invoice you will payout this new loan.
If your situation requires a longer term solution due to the winning of a contract, then Contract Finance might be for you. Contract finance is challenging to obtain but it is available. The most applicable situation might be for the provision of say large telephone systems or computer systems into blue chip public companies or government departments. These processes usually involve both the purchase of products as well as the installation and training of staff and can take months to complete.
Contract financing is supplied as a longer term advance based on both the contract conditions and your cash flow forecasts. Contract finance also swaps to Debtor Finance as soon as your invoices are issued to the customer.
Working Capital is the engine that drives the business. Too many times I see businesses that have the wrong type of structures for their working capital. It’s usually caused by a misunderstanding of the real needs of the business, a lack of products being available or a lack of planning. (Or all three at once)
Feel free to contact us about Working Capital, or post some comments on this page. I would be very interested to hear about your experiences with banks and other finance companies when discussing your working capital needs.