Working capital finance and purchase order finance are both very different things, but both can give struggling businesses the cash-flow boost they need.
Working Capital Finance
Working capital is the sum of current assets minus current liabilities and is an important measure of business health and liquidity. Working capital can tell us whether a business can meet all of its short-term debts as well as cover operating expenses, such as suppliers and payroll. If a business is profitable, it has positive working capital once the liabilities are subtracted. Inversely, if sales are sluggish or the collections process is inefficient, it has negative working capital.
When this happens, business owners frequently turn to personal savings to meet the requirements of the business. That said, seeking a source of external funding can also be a practical option, and there are many types of working capital finance on offers, such as invoice finance, business loans and overdrafts, to name just a few. Let’s consider the most common types here. Invoice finance
Invoice Finance
Traditional forms of working capital finance, such as invoice finance use outstanding customer invoices as a form of security. Invoice finance is typically structured as factoring and invoice discounting to meet varying business needs. For smaller businesses with lower value invoices and limited access to bank lending, factoring is more appropriate. As part of the agreement, the factor or factoring company manages credit control whereas larger companies with robust financial processes in place and creditworthy customers are more suited to invoice discounting.Invoice finance unlocks short-term working capital by raising funds against the value owed to the business through its unpaid customer invoices. For both factoring and invoice discounting, the process involves selling outstanding invoices to a financial provider and once the invoice is issued, the business receives an advance of 90%, sometimes up to 100% of the value of
Invoice finance unlocks short-term working capital by raising funds against the value owed to the business through its unpaid customer invoices. For both factoring and invoice discounting, the process involves selling outstanding invoices to a financial provider and once the invoice is issued, the business receives an advance of 90%, sometimes up to 100% of the value of the invoice. When the invoice is settled by the customer, the business gets the balance, minus fees.
As well as funding operating expenses, invoice finance also frees up cash for investment in growth projects, such as a large contract or a new market.
Working Capital Loans
Secured and unsecured loans are very different. For many businesses, an unsecured loan is the most practical way to increase working capital without risk to business and personal assets. However, they may find that these are difficult to get compared to secured loans, which have lower interest rates, higher limits and longer repayment terms. The big banks only tend to accept small businesses for an unsecured loan if they have a sound credit history.Working capital loans typically offer business finance, ranging between £1,000 and £50,000 with repayment terms of up to 36 months. The size of the loan will depend on the business’ credit history and profile. It’s possible to get unsecured business loans for larger sums, but for these types of loans, business owners may have to give a personal guarantee.
Working capital loans typically offer business finance, ranging between £1,000 and £50,000 with repayment terms of up to 36 months. The size of the loan will depend on the business’ credit history and profile. It’s possible to get unsecured business loans for larger sums, but for these types of loans, business owners may have to give a personal guarantee.
Overdrafts
Traditionally a quick and easy source of working capital finance for businesses across all sectors, arranged overdrafts are becoming more difficult to obtain. They are essentially a form of unsecured lending, so even if the business gets one as a short-term working capital fix, it’s likely that the limit will be low unless the business has a strong credit history, which can be problematic for investing in business growth.
Purchase Order Finance
Purchase order capital is the money that is used to bridge the gap between an order being placed and paid for by a supplier, and the payment is received by the end customer. The time lag between the two can be significant, particularly in industries where customer payment terms of 60+ days are commonplace.
How it Works
PO financing is a variant of traditional factoring, which involves businesses factoring receivables to meet their present and immediate cash requirements. In a similar vein, PO financing provides a fast, effective short-term cash injection when a business is unable to pay for goods or raw materials that are required to fulfil a large customer order where the end-customer is insisting on credit terms and is unwilling to pay a deposit. At the same time, the supplier is demanding a deposit or even payment in full prior to shipping. The business owner may already have an invoice finance (factoring and invoice discounting) facility in place but isn’t aware of the benefits of using PO financing.
Invoice finance and PO financing are similar, yet different. Unlike factoring and invoice discounting, which speeds up payment collection by releasing the cash tied up in unpaid customer invoices, PO financing gives businesses the potential to get up to a 100% advance against confirmed orders to provide goods to customers before an invoice is generated.
PO Funding Benefits
A common problem for startups, new and higher risk businesses across all industries, especially manufacturing, transportation & logistics and distribution, is receiving a large order from a company, which they frequently cannot fulfil as they do not have the working capital available to pay for the products to be produced. To fulfil the order, the business requires a substantial working capital reserve to fund the transaction until end-customer payment. Turning down the large order can mean a loss of revenue and a potential blow to its reputation.
In this scenario, PO financing is a practical solution, which is equally suited to new and well-established businesses that are experiencing difficulties being accepted for credit from suppliers. The level of PO funding will depend on the size of the order and the creditworthiness of the company issuing the order. Alternatively, PO financing can complement existing banking arrangements, with the added benefit of not taking on further debt that will appear on the company’s balance sheet.
When PO financing runs alongside an existing invoice finance facility, it can include bad debt protection to give the business owner peace of mind once they have placed the large order with the supplier right through to receiving end-customer payment. The funder typically charges a transaction fee and interest on the funds advanced. These fees are commonly repaid from an invoice finance facility once the goods have been delivered and the invoice is sent to the customer.
If sales growth is outpacing working capital or seasonal sales are putting a strain on cash flow, please call 08000 24 24 51 or email info@businessexpert.co.uk for free and confidential advice from one of our professional advisers.
