Small- to mid-sized businesses in need of short-term capital are often disadvantaged when it comes to qualifying for financing from traditional lenders. Many have neither the credit standing nor sufficient operating history to meet the requirements for bank lending. An increasing number of businesses are turning to alternative short-term financing that utilizes a business assets as collateral for extending cash advances or loans. Three of the more popular forms of short-term financing are invoice factoring, purchase order financing, and equipment financing.
Also referred to as receivables factoring, invoice factoring is the easiest form of financing for which small businesses can qualify. All it requires is the business has a collectible invoice less than 90 days old payable by a creditworthy customer. The business sells the invoice to the factoring company in exchange for a cash advance of up to 90% of the value of the invoice. The rest is held in reserve by the factoring company. When the customer pays the invoice, the factoring company remits the balance to the business minus a factoring fee of 3 to 5% per month. The business may continue to submit invoices and receive cash advances as needed. Invoice factoring is used to help businesses smooth out their cash flow while they are waiting for payments on invoices with extended terms.
Purchase Order Financing
Oftentimes, a business receives a major purchase order but does not have the capital to purchase the supplies or products to fill the order in a timely manner. Purchase order financing is used specifically as a capital source to pay suppliers to produce and deliver goods to be resold in anticipation of full payment by end customers under the regular terms of their invoice. When a company receives a purchase order, the lender agrees to pay the supplier up to a certain percent of the cost of supplies using the purchase order as collateral. The purchase order might be for $100,000 in goods, but the cost of supplies to fulfill the order might only be $70,000. The lender might advance up to $50,000 or more, depending on the reputation of the supplier and the creditworthiness of the customer placing the order. When the order is delivered and the customer is invoiced, the lender collects the invoice amount based on the terms of the invoice and remits the balance to the company.
For many businesses, equipment financing is probably the most familiar form of asset-based lending because it is the easiest to understand and, for the most part, the easiest to obtain. Financing is based on the equipment being purchased, which is used as collateral for securing the loan. Lenders view it as fairly low-risk financing because it is backed by the value of the equipment. When financing equipment with a loan, the lender uses the value of the equipment to determine a borrowing base, which is the amount of money a company can borrow. For equipment, the borrowing base is a percentage of the liquidation value of the equipment, which is typically calculated on a loan-to-value ratio of 50%.