Board Topic: Line of Credit for small business accounts receivable financing
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Line of Credit for small business

Posted by: loanuniverse Nov 1 2004, 10:47 AM
In another website that I frequent, a visitor posted a message about how to refinance an existing line of credit that he had gotten for the business, but that required a mortgage on the primary residence of one of the partners. His first intention was to refinance the line with low rate credit cards. The business had just been bought by the partners and they were looking for a way to change the financing. The goal was to get financing without having to pledge the house.

I am of the opinion that once you understand how lenders look at credit, you are armed with powerful ammunition that will help you present your business in the best possible light. Therefore, I answered his question from that perspective, and maybe some of my visitors will benefit from my answer.

My response to his question is as follows:

Why not try to replace the line with a similar line to finance accounts receivable without the mortgage? I underwrite these types of financing all the time. Granted, I usually only look at requests over $500,000, but the credit is looked at the same way.

First, What is the quality and turnover of those receivables? In short-term working capital lines used to finance trade assets, the primary source of repayment is conversion of those assets. In layman’s terms this means that the lender is looking to get paid when the account debtor pays on the invoice that is being financed. The lender will look at trends in repayment and the strength of your customers.

Second, the lender will look at cash flow from operations as a source of repayment. This goes beyond looking at income as shown in the financial statement. Cash flow is the actual cash coming in or in bad situations “coming out” of the business.

Finally, the lender will look at the guarantors and other ways to strengthen the credit. My guess is that the lender either saw something he did not like in the primary and secondary source that he is mitigating with the mortgage or that the bargaining position is weak and the lender took advantage of it.

Certain things that lenders do not like:

- Slow paying receivables.
- Foreign receivables.
- Concentrations of receivables in one or only a couple of accounts.
- Negative net worth.
- High leverage
- Lack of management experience
- High levels of inventory
- History of unprofitability

And unfortunately those are some of the most common, only looking at your financials can a lender figure out if you make a good candidate for the credit.

I would stay away from financing a business with “credit cards”, I would try to replace the LOC at once. Hopefully, by then you would have closed fiscal year 04 and you can show the performance of the business under the new management.

Good luck

Posted by: Rick Nov 1 2004, 02:38 PM
As a follow on to the above, my organization (Canadian provincial gov't lending / business development org.) spends considerable time trying to get our clients to seriously consider receivable financing / factoring. Often we have clients looking for working capital loans when all they really need is a quick lesson in cash flow management. Many are unaware of the impact on their cash flow that a slow receivable can make (they all understand that a receivable out 60 days has a bigger impact than, say, a 30 day receivable, but they sometimes have a challenge seeing the positive impact on their cash between a 10 day receivable and a 30 day one).

Commercial banks tend to have the least flexible terms when it comes to financing receivables. They tend to be all or nothing -- i.e. they want all your business, and want to factor all receivables. Plus, they tend to be only interested in high volume / $$ transactions. (Note: this does not imply that I think they are wrong in their approach, I'm just pointing it out! biggrin.gif )

As well, there are (credible) factoring companies out there who will do one-off factoring for decent rates. Others will only factor export receivables provided the receivables are insurable with a gov't export organization.

Whichever route is chosen, it can make a very positive impact on your cash flow and thus your business.



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