© Dimdimich | Dreamstime.com
Belt Tightening 6531f51561ca1

When the Markets Tighten and Cash Stops Flowing, What's Next?

Oct. 20, 2023
Working capital financing may be an alternative for smaller manufacturers disproportionately affected by a credit crunch.

The one-two punch of a slowing economy and tightening credit environment can be especially difficult for small and mid-sized manufacturers that rely on loans and credit lines to fund facilities, equipment, machinery and day-to-day business needs in capital-intensive industries.

Manufacturers can experience cash flow shortages for many reasons, even when they’re generating significant revenue:

  • Misalignment between customer payment terms and a company’s cash outflow needs.
  • Company growth that is faster than conversion of their invoices to cash. 
  • Inflexibility in existing lending options due to customer concentrations, financial covenant defaults, etc.

Manufacturers may not be aware of alternative financing options to gain access to funding, beyond traditional lending, which may be especially beneficial in a downturn. Alternative financing can include private equity funding, venture capital, lines of credit and more. It can also include working capital financing, or the ability for businesses to gain access to funds based on the value of the company’s assets rather than financial performance metrics. 

Working Capital Solutions

Three of the most common working capital solutions include:

1.  Accounts Receivable (A/R) Financing: leveraging cash tied up in a company’s accounts receivables to meet payroll, inventory and other working capital needs. Terms and availability are typically based on the company’s ability to pay rather than the borrower’s historical performance. 

2.  Asset-Based Lending: enables businesses to leverage their existing inventory, accounts receivables and equipment to gain access to capital. These loans can be tailored to business needs for a one-time capital infusion or continuous line of credit and types of assets used. 

3. Leasing: Businesses can leverage existing machinery and equipment to generate immediate liquidity amortized over several years through a lease contract or finance new equipment purchases stretching cash outflows over several years. This can help to meet immediate capital needs while maintaining stronger cash flow with typically more affordable and predictable lease payments over time.

When might working capital be a good fit, or supplement to, traditional lending for manufacturing businesses?

When Credit Shrinks

A primary difference between working capital and traditional bank lending is in what the lender looks at when underwriting a loan. A traditional lender looks first at the historical profitability and cash flow of a business, while a working capital lender primarily looks to a company’s assets—accounts receivables, inventory and/or equipment. This fundamental difference can have a big impact on availability of funds during an economic downturn.

During a recession, banks typically clamp down on credit availability to safeguard their financial health and mitigate losses due to economic uncertainty and declining customer credit quality. For businesses, this cautionary approach can severely curtail access to funds when they may need them most.

Conversely, with working capital, the impact of a slowing economy is far less immediate or direct. Because working capital solutions are typically based on business assets, companies can continue to access funds to support their objectives for as long as those assets maintain value.

Asset-based loans, for instance, are governed by a “borrowing base” of agreed-upon advance rates on the assets of the company and possibly financial covenants based upon the company’s projected financial expectations. Asset-based lenders rely on the creditworthiness of the borrower’s customers and their payment history to determine the borrower’s ability to borrow. By focusing more on the credit quality of the borrower’s customers, the asset-based lender may be able to provide higher advance rates (i.e., on the eligible accounts receivables and inventory) and greater availability compared to traditional bank sources.

Changing Financial Needs

This leads to another important difference between traditional loans and working capital financing. Whereas most traditional lenders may review a company’s financials once a month, alternative lenders are, typically, far more familiar with day-to-day business and financing needs of business customers. They continuously monitor asset value and availability, often allowing them to be more in-tune to the evolving capital needs and financial situation of a company.

When changes to a customer’s financing needs arise, they often are already aware of and able to respond. Expanding an asset-based credit line might take a day or two, versus up to 30 days or more for a conventional line of credit.

Other benefits can include more flexible access to funds, more competitive interest rates and/or less stringent covenant restrictions than other types of financing.

Could Working Capital Lending be a Fit?

How might manufacturers assess whether working capital solutions might be a good fit for their business? Here are a few considerations:

1.  Assess your cash flow needs and the nature of your business. Determine whether there are frequent gaps between customer payments and your own cash outflow requirements or if your growth is outpacing your ability to finance that growth with your traditional line of credit.

2. Evaluate the flexibility and limitations of your existing lending options. If your current lending arrangements are restricted due to factors such as customer concentrations,  financial covenant defaults or reporting limitations, working capital solutions could provide a more adaptable alternative.

3. If you need ongoing access to capital, want to leverage your existing assets or require more immediate liquidity for your business operations, working capital options like accounts-receivable financing, asset-based lending or leasing may offer favorable terms.

Working capital is less likely to be a fit if your business has:

1. A lack of tangible assets

2. Progress-based sales

3. Inability to provide reporting on sales and inventory

4.  Foreign or consumer customer base

5.  Higher risk and volatility

What to Look For

When it comes to working capital, businesses should look for:

  • A lender with proven experience that includes seasoned professionals and a strong source of liquidity
  • Understanding of your industry, and your specific needs. A partner that explains the process and makes you feel comfortable
  • A dedicated team that understands your industry, business structure, market, sales fluctuations
  •  Recommendations and referrals from others

As the economy continues to pose challenges for many manufacturers, working capital can be a good alternative to consider to augment traditional options to address business needs and growth.

Mick Goik is president at Oxford Commercial Finance. He draws on a rich background in working with businesses and entrepreneurs in the financial services industry, including consulting with them on successful acquisitions, new product development and financial growth. He has also served as EVP, head of Commercial Finance division of MetaBank and President and COO of Crestmark Bank.

Sponsored Recommendations

Voice your opinion!

To join the conversation, and become an exclusive member of IndustryWeek, create an account today!