Financing Growth Through Suppliers
Editor's note: This article was excerpted from Financing Your Business Made Easy.
If you've survived the startup stage and are now running a successful company, congratulations! Now is the time to look to new sources of cash in order to grow your business and possibly take out some of the cash you put into your startup to replenish your personal savings. We have all heard stories about entrepreneurs who emptied their piggy banks to start their companies, plowed every penny earned back into their companies, and then had nothing in reserve when the companies fell on hard times.
Of course, you shouldn't expect that your company will encounter difficulties. But you should be ready for that eventuality. Reclaiming some of your initial investment is a way to cushion yourself and your family against any business downturn. Recapitalizing your company and restructuring your company's balance sheet is an important step when growing a business.
Once you have established a track record as a viable business, it is possible to borrow from a bank or finance company on better credit terms than you could have received as a startup. In this article, however, we want to focus on an avenue open to growing businesses that isn't generally open to startups: Working with suppliers to minimize the cash you have to put out to buy production-oriented as well as non-production goods.
Suppliers: Good Cash-Flow Management Is Money in the Bank
Suppliers (or vendors) provide you with the materials, components and other production-oriented goods that go into your product, as well as the goods and services you need to run your business. So, why do they belong in an article about financing growth?
Suppliers don't normally provide capital for your business in the form of a cash investment in exchange for equity. However, they do offer credit to their customers. Working closely with your suppliers can help you capitalize your business by better managing your cash flow.
If you produce, distribute, or retail products, there are three ways suppliers can help you manage cash flow and reduce the need for working capital in the form of cash:
- Buying on credit
- Buying on consignment
- Supplier-managed inventory
Buying on Credit
Most suppliers of goods (and some suppliers of services) are willing to provide favorable credit terms to capture new business. Of course, the best credit terms are usually extended to companies with the best credit history.
Suppliers are often willing to work closely with a customer that is a young and growing company, since there is a good chance the customer will return the kindness when it becomes larger and better established. Filling small orders, extending no-interest payment from 30 to 60 days for a few years, and providing favorable credit terms are all ways in which suppliers can build relationships with their customers.
As your company grows and after you have established a credit history, it's a good idea to revisit the issue of credit terms with each of your current suppliers. A common way to begin is by checking with competing suppliers to see if they will offer better terms. You can use an offer of better terms to try to get your current supplier to match those terms in order to keep you as a customer. Of course, your current supplier may refuse to match the credit terms offered by the competitor. Then you have to decide whether to switch on the basis of price or to stay in the supplier relationship you have built over time.
Most suppliers do not charge interest on payments made within 30 days (and sometimes 60 days) of the date of purchase. This means that if you have a quick production process or a distribution or retail business that moves goods quickly to your customers, you may have a lag between the time you receive payment for your sales and the time you must pay your suppliers for those goods. In this case, you can earn interest on the money in your possession during that lag, a situation known as "playing the float."
That is how supermarket and fast-food outlets keep their prices and profit margins low and still make money for their owners. The profit margin on a fast-food meal, for example, is essentially 0 percent. That means it costs the franchise owner of a Burger King or Wimpy's or Dunkin' Donuts as much to buy the food and paper goods, lease the space, hire the help, and take a salary every month as the store takes in from customers.
Yet the franchisee still earns a profit if suppliers allow 30 or 60 days to pay with no interest charge, the rent comes due only monthly, and paychecks are cut every week. Every night the day's cash goes into a cash-management account at the bank where it earns interest until the bills fall due. For a company with a large daily turnover, the daily float can generate sizable yearly profits.
Remember: in the case of fast-food outlets, whoever owns the franchise (a franchisee or the company) also owns the real estate on which the store sits. The greatest profit for a long-time owner of such an outlet is the real estate when it is sold.
Even if your throughput time (the time your inventory is in your facility, be it production, distribution or retail) is such that you must pay your suppliers before your customers have paid you, most suppliers will extend you credit at a rate lower than you would pay for an unsecured bank loan and certainly lower than for your credit card.
Buying on Consignment
Some suppliers may be willing to sell you production materials on consignment, meaning that you pay only for what you use and can return unused materials over a specified period of time. Consignment raw material inventory is usually offered by companies that deal in products with an infinite life, such as steel or plastic resin. If you return the unused inventory six months after you take possession of it, the supplier can usually find another customer.
Consignment buying is based on the honor system; you write a check to the supplier every month for the amount of material you have actually used.
Sometimes a supplier will sell you a standard amount of material every month based on your best estimate of production and provide you with more material (safety stock) on consignment in case you have higher demand than predicted.
Many suppliers also sell to retail outlets on consignment. This is typical in the clothing industry, where the financial risk has always been on the brand-label companies rather than the retailer. If an item falls out of fashion between the time it is designed and the time it appears on retail store racks, the brand-label company is stuck with a lot of unsellable goods.
Supplier-managed inventory is a technique used in manufacturing. A supplier accepts a large order for a certain amount of raw materials, components or sub-assemblies that the customer will use over a long period of time. Then, the supplier delivers to the customer only the amount of goods needed for a week or a day of production, holding the remaining inventory in its own facilities. A supplier that manages your inventory may also store parts or components from other suppliers and then kit materials from many suppliers for delivery to you.
Suppliers charge a premium to manage your inventory for you, but it is often cheaper to pay the supplier to do it than to finance and build a facility for your production-oriented inventory. Whether you hold the inventory or the supplier does, the payment for the goods themselves will be the same.
Maintaining good supplier relations and managing inventories with your suppliers are only two aspects of sound cash management. Another two are timely collecting of accounts receivable and daily posting of income into your cash-management account.
Good cash management can win you the respect of banks and other lenders, which in turn can enable you to borrow early in your company's growth cycle and at favorable terms. In addition, banks will often consider references from suppliers (sometimes called trade creditors) when considering a loan request.
For more information on ways to raise money for your new or established business, read Financing Your Business Made Easy from Entrepreneur Press.
Addressing the diverse challenges at all stages of business, Entrepreneur Press provides actionable solutions to help you excel in all your business ventures. Whether starting and operating a business, leading people or companies, building a brand, engaging customers, or investing for the future, our paperback books and ebooks aim to help you achieve success both in business and in life. Learn more at EntrepreneurBookstore.com