Working Capital Financing Basics For Small Business Owners

The common wisdom for many complicated problems is often a variation of “it might be time to get back to basics”, and working capital loans currently represent an ongoing example of this advice for small business owners. Working capital management is the universal art and science of short term cash management for businesses. Because of the recent ineffectiveness that prevails with commercial banking, working capital financing can no longer be taken for granted by any business owner.

Because of declining sales occurring simultaneously with decreased availability of bank financing, ensuring adequate business cash flow has become a higher priority for most businesses. In one common occurrence, borrowers are likely to attempt to juggle the timing of expenses whenever possible in an effort to match receipt of business income. Business owners will realistically be forced to “get back to working capital financing basics” because this is not an ideal solution under any circumstances.

A primary alternative for any business to explore in their efforts to deal with a mismatch of income and costs is business expense reduction. Credit card processing is a significant cost to evaluate. This is frequently an expense area that is overlooked because the credit card processing provider was chosen for convenience or perhaps because they were recommended by a banking or other professional relationship. Analyzing alternative providers in conjunction with obtaining a business cash advance is one of the most practical methods for reducing this cost. By combining efforts to obtain additional working capital (via merchant financing) with a change of processing services, a dual cash flow benefit can be achieved by receiving commercial financing while simultaneously reducing a major cost. Certainly there will be those who say that this is easier said than done, and it is appropriate to emphasize that this process should involve the close involvement of a business financing expert who is familiar with all aspects.

Looking at whether it is feasible to reduce overall bank financing is another potential cost reduction. For almost every conceivable commercial finance service, many banks are increasing their fees. Businesses should increasingly try to reduce their business debt levels to avoid some of the bank fees altogether. The option of firing a current bank and replacing them with a new bank charging more reasonable fees will need to be emphasized when this is not practical.

Small business owners will quickly realize when they review working capital basics that the most effective commercial financing sources have changed during the past few years. The more active role that banks have traditionally played in providing both working capital loans as well other forms of commercial loans has been quietly stopped (or significantly reduced). Commercial borrowers might need to be alerted that there are both “new basics” and “old basics” for most working capital management situations, and this is the rationale for making the last observation. The entire process of reviewing “working capital basics” will help businesses realize how other business financing options are likely to be more effective in resolving their predicament than the traditional bank solution of taking on more business debt to resolve the described problems.

Small Business Financing Options – Despite the Credit Crunch

There’s no question that the financial crisis and ensuing credit crunch have made it more difficult than ever to secure small business financing and raise capital. This is especially true for fast-growth companies, which tend to consume more resources in order to feed their growth. If they aren’t careful, they can literally grow themselves right out of business.

Amidst all the gloom and doom, however, it’s important to keep one thing in mind: There are still options available for small business financing. It’s simply a matter of knowing where to look and how to prepare.

Where to Look

There are three main sources you can turn to for small business financing:

Commercial Banks – These are the first source most owners think of when they think about small business financing. Banks loan money that must be repaid with interest and usually secured by collateral pledged by the business in case it can’t repay the loan.

On the positive side, debt is relatively inexpensive, especially in today’s low-interest-rate environment. Community banks are often a good place to start your search for small business financing today, since they are generally in better financial condition than big banks. If you do visit a big bank, be sure to talk to someone in the area of the bank that focuses on small business financing and lending.

Keep in mind that it takes more diligence and transparency on the part of small businesses in order to maintain a lending relationship in today’s credit environment. Most banks have expanded their reporting and recordkeeping requirements considerably and are looking more closely at collateral to make sure businesses are capable of repaying the amount of money requested.

Venture Capital Companies – Unlike banks, which loan money and are paid interest, venture capital companies are investors who receive shares of ownership in the companies they invest in. This type of small business financing is known as equity financing. Private equity firms and angel investors are specialized types of venture capital companies.

While equity financing does not have to be repaid like a bank loan, it can end up costing much more in the long run. Why? Because each share of ownership you give to a venture capital company in exchange for small business financing is an ownership share with an unknown future value that’s no longer yours. Also, venture capital companies sometimes place restrictive terms and conditions on financing, and they expect a very high rate of return on their investments.

Commercial Finance Companies – These non-traditional money lenders provide a specialized type of small business financing known as asset-based lending (or ABL). There are two primary types of ABL: factoring and accounts receivable (A/R) financing.

With factoring, companies sell their outstanding receivables to the finance company at a discount of usually between 2-5%. So if you sold a $10,000 receivable to a factor, for example, you might receive between $9,500-$9,800. The benefit is that you would receive this cash right away, instead of waiting 30, 60 or 90 days (or longer). Factoring companies also perform credit checks on customers and analyze credit reports to uncover bad risks and set appropriate credit limits.

With A/R financing, you would borrow money from the finance company and use your accounts receivable as collateral. Companies that want to borrow in this way should be able to demonstrate strong financial reporting capabilities and a diverse customer base without a high concentration of sales to any one customer.

How to Prepare

Regardless of which type of small business financing you decide to pursue, your preparation before you approach a potential lender or investor will be critical to your success. Banks, in particular, are taking a much more critical look at small business loan applications than many did in the past. They are requesting more background from potential borrowers in the way of tax returns (both business and personal), financial statements and business plans.

Lenders are focusing on what are sometimes referred to as the five Cs of credit:

o Character: Does the company have a strong reputation in its community and industry?

o Capital: Lenders usually like to see that owners have invested some of their personal money in the business, or that they have some of their own “skin in the game.”

o Capacity: Financial ratios help lenders determine how much debt a company should be able to take on without stressing the finances.

o Collateral: This is a secondary source of repayment in case a borrower defaults on the loan. Most lenders prefer collateral that is relatively easy to convert to cash, especially equipment and real estate.

o Conditions: Conditions in the borrower’s industry and the overall economy in general will play a big factor in a lender’s decisions.

Before you meet with any type of lender or investor, be prepared to explain to them specifically why you believe you need financing or capital, as well as how much capital you need and when and how you will pay it back (if a loan) or what kind of return on investment a venture capital company can expect. Also be prepared to discuss specifically what the money will be used for and what kind of collateral you are prepared to pledge to support the loan, as well as your sources of repayment and what measures you will take to ensure repayment if your finances get tight.

You should also ensure that your financial statements and records are current and that your internal control systems are adequate for handling the level of accounting and bookkeeping lenders and investors expect.

Small Business Finance Vs Corporate Financing . Fundamentals And Advantages In Canada

Small business finance in Canada. Whets the difference, asks our clients between their capital needs and corporate financing in Canada. We work with both types of firms and there is a case to be made that ‘ SIZE COUNTS ‘, but you might be surprised at how. Let’ dig in!

Business owners often hear the business fact that small and medium enterprises are in fact the largest employer and the true ‘engine ‘of the Canadian economy. It is also reasonable to assume that many business owners and the management of smaller and medium size firms worry about competing against the big global giants.

These larger competitors in many cases have ‘brands ‘, as well as unlimited financial strength.

However, do business owners really know what those competing challenges are and how they can focus in on addressing them in some manner? In many cases (not always) they also have access to finance solutions available to larger corporations. They just didn’t know it!

As mentioned previously financial strength of big firms and financial limitations of smaller firms is certainly a key area. Small and medium sized firms continually focus on cash flow and are challenged by working capital. The banks and larger financial institutions can be forgiven for wanting to lend more to larger corporations, since their loans are safer and more collateralized.

The small firm can’t finance their customers in the manner that larger corporations can. The large corporations even usual financial strength to further compete against product and price by offering financing arrangements via their captive finance companies – think IBM CREDIT CORP as an example, or Caterpillar Finance. Just some examples.

Smaller firms are also challenged by personnel issues; they have trouble retaining key successful employees around issues such as compensation and benefits. Owners are focusing on day to day problems and challenges, and can’t always think long term in areas of employee development, etc.

Naturally smaller firms pay more in direct costs because they don’t have buying power; as well they are often focused on a couple core products and competencies. Larger corporations can diversify geographically and product wise as we know. Financing costs and interest rates in general have always favored the larger companies who borrow.

Intuitively the consumer or business customer gravitates towards a larger corporation for products and services, if only for the perceived safety and warranty issues.

Well, we have seen areas where the big guys clobber the small guy. Let’s turn the boat around!

Service/Service/Service – have we made out point?! Value add in smaller firms is often service and support. Customers want the personal touch and they clearly get that from a smaller firm.

Also, in a smaller firm, in general the business owner is very focused on working harder and longer with their customers – big corporations tend to favor broad stockholder approval.

The smaller firm is also more adept, and can move more quickly to adapt to market needs. Big companies can take a long time to react to competitive change. Communication and market needs are much focused in a small company – it might take days, weeks, and years for larger corporations to implement major market changes.

Customers and consumers hate bureaucracy, and smaller firms certainly have less of that – decisions are made easier, customer situations are rectified more quickly.

In summary, business owners often have a fear of the ‘gorilla ‘in their industry – the big corporate giant with brand and financial clout. Instead they should focus on specialized market segments, localization of their services, personal service, etc.

It doesn’t hurt to be a small /medium sized firm if we do it right! While larger corporate borrowers have access to low rates and flexibility and unlimited capital offer by Canadian chartered banks, insurance companies, capital markets, etc the reality is that many of these solutions, sometimes downsized and costing more, are still available to the SME sector.

Solutions include:

A/R Financing
Vendor financing
Equipment finance
Non bank asset based lines of credit
Inventory financing
PO/SUPPLY Chain financing
Monetization of SRED or Film tax Credits

Whether you’re in the SME sector in Canada or a mid market borrower seek out and speak to a trusted, credible and experienced Canadian business financing advisor who can assist you with your cash flow and asset financing needs.