April 5, 2019 Avoid a Cash Crunch After an Equipment Upgrade

Alternative financing bridges the cash flow gap after an expensive plant upgrade.

April 4, 2019

Manufacturers are often faced with making the difficult choice of maintaining existing equipment and leaseholds or undertaking what could be expensive upgrades to their equipment and/or expansions to their plant. Often times a slowdown or downtime in production during the upgrade, coupled with slow paying customers, will put a significant strain on the business’s cash flow. Many manufacturers undertaking such projects often will turn to non-conventional financing sources to support the equipment purchase or plant upgrades in order to make sure their financing source remains consistent and is comfortable with the potential disruptions that come with projects of this nature.

For the equipment upgrades, manufacturers have various funding options to aid in the acquisition including leasing, term loans from their lender, or even using their own cash. Large projects such as plant expansions are most often financed via a term loan. Choosing the best option depends on the business’s current financial situation and its long term goals. If the equipment needs to be replaced or upgraded frequently then leasing may be a good option; if the equipment has a long useful life or needs to be altered to produce a specific product, a bank loan might be the better fit as leasing agreements often have restrictions on equipment alterations.

Closing the Cash Flow Gap after a Plant Upgrade or Retrofit

Manufacturers often feel the effects of the new equipment installation or plant upgrades on their cash flow which is caused by the downtime for the equipment to be installed, or the disruption caused by physically expanding the plant, and the time it takes to resume normal operations.

Having the appropriate financing source in place to support their working capital needs after completing these types of upgrades is just as important as financing the upgrades themselves. Asset-based lending (ABL) and invoice factoring are two financial products that businesses can turn to in order to close the cash flow gap and improve liquidity after an expensive plant upgrade.

Asset Based Lending (ABL)

ABL allows businesses to leverage their assets (accounts receivable (A/R), inventory, equipment, and real estate) to obtain financing for working capital, equipment upgrades, or other required projects. ABL’s will provide a revolving line of credit utilizing A/R and inventory while many will also provide term loans against equipment or real estate. ABL is more suited for dealing with the inconsistent financial performance or explosive growth that may come as a result of changes to a company’s plant or equipment. Given that an ABL will analyze and rely on the historical and projected financial performance of the borrower, it is best suited for established businesses with adequate accounting controls and processes.

Factoring

While factoring companies generally will not provide term loans to help with the previously discussed projects, a factoring facility, working in conjunction with other leasing or term loan providers, can be a great solution to help manage through the tight cash flow caused by such projects. Through factoring, businesses can obtain funding against their outstanding A/R at advance rates that are higher than with ABL or conventional bank loans. This means the business gets more money which improves overall cash flow. Approval for a factoring facility is fairly quick and is less expensive than other alternative financing options such as credit cards or a merchant cash advance (MCA). In addition, the factor provides A/R management services such as credit qualification and receivable collections as a standard practice, which can mean less work for your finance team.

Both, ABL and invoice factoring, provide manufacturers with the needed financing to bridge the cash flow gap after an expensive equipment improvement project. Both are based on a renewable asset – the A/R, and the financing facility has the flexibility to grow as the A/R and inventory grows.

Because the ABL or factor approves the financing facility with a heavy emphasis on the quality of the company’s assets, not solely on the company’s financial performance, businesses that normally would not qualify for bank loans have access to working capital or can get more cash flow support through alternative financing sources.

Prepare the Books to Get the Most Financing at the Lowest Price

No matter which type of financing is chosen, financing sources will require financial documentation on the business before making a decision to fund. If the business is incapable of producing financial statements, it will likely result in the funding request being denied. In a recent survey, business owners and directors stated not being able to demonstrate viable business projections as the number one reason for being turned down for funding (27%) while a poor credit rating came in second place at 20% (Global Business Monitor by Bibby Financial Services).

The advance rate and/or interest rate may be impacted negatively from the levels initially proposed if the underwriting team discovers inconsistencies or out-of-date information in the business’s books and records during the due diligence process. There are a few simple steps that manufacturers can take to make the process go smoothly:

• Write-off any old accounts receivable – if the receivables are old and you have taken multiple steps to recover the money without success, there is little chance that the invoices will be paid.
• Ask customers for payment on overdue but collectible invoices before due diligence begins. If a customer cannot pay the full overdue amount, see if you can agree on a payment plan.
• Separate and dispose of any old or obsolete inventory. You can work with a liquidator to sell off aged inventory and raise capital for your equipment upgrade project.

Full disclosure is critical in dealing with a financing source. On top of presenting up-to-date books, manufacturers should be ready to address any weaknesses of their businesses upfront with the financer. It can be more costly if the lender discovers a major issue on their own.

To avoid surprises, ask the financer for a complete breakdown of the types of services and fees associated with the funding facility and how often these get revised. Finally, don’t base your decision of which funder to go with purely on the interest rate. Look for a partnership with a funder that allows for flexibility in the financing to adapt to your business’s ever-changing needs.

About the Author
David Ciccolo is Managing Director of ABL and Factoring at Bibby Financial Services (BFS) in the US. He has over 30 years of experience in commercial banking, factoring, and ABL. BFS funds over 10,000 businesses worldwide from start-ups to well established mid-size companies. For more information, visit www.bibbyusa.com.

Subscribe to Industry Today