Getting a large order can be either a blessing or a source of major problems for a company. It’s an obvious blessing if the company has the resources to fulfill it. However, if the company doesn’t, large orders can create havoc. It must scramble to find the resources to fulfill it. This task is particularly difficult if the business needs funds to pre-pay suppliers. If it cannot find the money, it may be left with the painful alternative of declining the order.
Unless a company has funds to pay for supplier costs, it will need to rely on some form of credit. This article presents four credit alternatives that can help finance large orders.
1. Vendor credit
The first and most obvious choice is to use vendor credit. If a company has good commercial credit, vendors may provide 30 to 60 days to pay invoices.
Vendor credit is a cost-effective financing tool, as it incurs no cost to a business. Effectively, vendor credit is the equivalent of an interest-free loan.
This option does have some limitations that owners must keep in mind. For example, a vendor may be unwilling to extend the amount of credit needed, especially in cases of a very large order. Or, if a business is working on multiple projects, it may exhaust its vendor credit.
For more information, please read Glass Magazine’s 2014 article, “Your Profits: The Right Way to Build Credit with Your Vendors."
2. Bank financing
Conventional bank financing is another good alternative for large orders. Unless the company is buying an asset, such as equipment, I always favor lines of credit over business loans. Lines of credit have reasonable rates and provide the most flexible financing. These features make them ideal for project financing.
Lines of credit also have the advantage that they can work as backup cash reserves. This advantage is important because it allows companies to access funds that were previously tied up. Consequently, lines of credit provide management with more freedom to handle opportunities.
However, getting bank financing is often a long and detailed process. Banks usually require financial statements from the past two years, substantial assets/cash flow, and the maintenance of certain financial indicators, among other requirements. Furthermore, it can take weeks or months to gather the necessary documents and get an answer from the bank.
Lastly, management should secure the financing offer from the bank before submitting a bid for a project. Otherwise, the company could end up with a project and no financing.
3. Supplier financing
Supplier financing is a relatively new product that is offered by a few companies. It extends the amount of vendor credit a company gets by leveraging a company’s creditworthiness.
A finance company intermediates the purchase of goods between a company and supplier for the specific project. The finance company buys the goods from the supplier and resells them to the company at a small markup. Like any vendor, the finance company provides 30 to 90 days or more to pay the invoice.
To qualify for supplier financing, a company must be creditworthy. The finance company reviews the two most recent financial statements as well as accounts receivable and payables aging.
Some providers require that a company be credit insurable. This insurability helps cover the finance company if a business were to default on an invoice.
4. Owner’s personal loan
Business owners can also get a personal loan against their own assets. Owners can use these funds to provide a capital injection to the business. In turn, the capital injection allows a company to fulfill larger orders. In principle, this option sounds like a great solution.
Most owners have only one personal financeable asset—their home. A home equity line of credit, or HELOC, allows them to tap into the equity and invest it into the business. HELOCs can provide great flexibility. Furthermore, they fund quickly and have reasonable financing costs.
This method of financing is popular. However, I discourage most business owners from pursuing this avenue. In my opinion, the risk is too high. If the business transaction fails for whatever reason, the owner is stuck with substantial mortgage debt.
This outcome adds to the owner’s financial burden and creates a long-term liability against their home. Furthermore, if worse came to worst, the loan could also jeopardize the owner’s home. No single transaction, in my opinion, is worth that risk.
Which financing path is best?
My recommendation is to use vendor credit for a project when possible. It is cost-effective and very easy to manage.
The choice between a line of credit and supplier financing is more complex. I am inclined to suggest a line of credit because of its flexibility. An owner can use the line as often as they need without having to qualify each transaction. Furthermore, lines of credit are cheaper than supplier financing.
Owners can consider supplier financing if they prefer to avoid debt or if they already have a line of credit. Most supplier financing programs do not place a lien on collateral and can be used on top of an existing line of credit.
