On September 25, 2019, Troy Skabelund presented a webinar for Navigator Business Solutions to discuss 5 common pitfalls many businesses make when financing inventory. These issues, he explains, are often blind spots to businesses that hold inventory.
In this webinar, Troy discusses not only how to avoid these common pitfalls and finance your inventory more strategically, but also addresses 4 ways to manage your business finances in a smarter, more sustainable way.
5 Common Pitfalls Small Businesses Make When Financing Inventory
Below are the 5 common pitfalls small businesses often make when financing inventory. You may also watch the full webinar on Navigator’s website by clicking the button below.
1 – Prematurely Using Equity
Equity is the most expensive form of financing. Many businesses look toward equity much too early. However, it’s important to remember that equity makes you lose partial or even full control over your business. Don’t play the equity card too early in the game or you’ll walk away with much less than you might have otherwise. If you do choose to use equity to finance your inventory, do so in the form of convertible debt. This allows you to treat the financing as debt until you do a large equity raise, and defers a formal valuation of the business until later (when it will be further along and worth more).
2 – Whirlpool Debt
Merchant cash advances (MCA’s) can be tempting because they offer easy cash—and offer it quickly—but interest rates are often sky-high (often as high as 300%). They also tend to break down their terms in intentionally confusing ways so people think they’re getting a better interest rate than they really are. In addition, other lenders see using MCA lenders as a desperate act and will often decline to lend to a company using this form of financing.
Not all mezzanine lenders are dangerous, but it is very easy to get in over your head and potentially even lose control of your business. These types of lenders should be approached with significant caution and only when you’re absolutely certain you can handle the terms of the debt.
3 – One-Size-Fits-All Financing
Some lenders have a one-size-fits-all lending platform. They often have canned terms and collateral with a fixed duration. However, lending is—and should be—an individualized process. One-size-fits-all financing often means you’re getting more than you need (or want) in order to qualify. It may also require too many personal guarantees or have hidden terms that can be a poor fit for certain business types. Whenever possible, work with lenders who understand your industry and business, and who tailor their debt offering to your specific needs and situation.
4 – Over-Reliance on Personal Credit
There are many lenders who press for personal guarantees. There are also many business owners who assume any credit they receive will have to be based on their personal credit—putting their personal assets at risk. However, there are avenues a business owner can pursue that offer access to debt without a personal guarantee. But these strategies require some advanced planning. Sometimes a personal guarantee is necessary, but by avoiding one owners protect themselves from having a single credit-impacting event (such as a major health crisis or divorce) affect their ability to cover debt service—putting their entire business at risk.
Instead of relying on personal credit, build your business credit. Treat your business like a new college student and focus on strengthening its credit. Establish a business credit card, then run essential expenses through the card and pay it like clockwork. Understand the criteria to have the credit limit increased and work to earn those increases. Apply for a small credit line with your key suppliers—even if just for your smallest orders. Then pay those lines consistently. With time you will be able to grow your credit history and credit worthiness, qualifying for better rates, larger credit limits, and expanded debt options.
5 – Inherent Business Model Challenges
A company faces a business model conflict if its customers pay the company slower than the company has to pay its vendors. When cash comes in slower than it goes out, things can get ugly really fast. This can be quite common, since businesses often pay their employees and contract labor every week or every other week, while customers often pay in 30, 45, or even 60 days. And if your customers are larger than you, they can sometimes demand up to 90 day terms. Ouch! In addition, manufacturers often require partial or full payment before they start production or release the finished goods. Add time to ship and sell the product, plus time to invoice and collect payment and this can become a real problem for a small business.
This is an incredibly common situation in inventory-based companies and companies heavily dependent on labor and it is rarely self-correcting. Think you can grow your way out of a business model conflict? Chances are you will just create a bigger Frankenstein monster. As the business grows and requires more inventory and more labor, this problem becomes bigger and bigger—and is one of the reasons many companies fall into bankruptcy.
There are several ways to address these challenges more strategically, including:
- Reformulating your B2B contracts to bill more frequently. Billing once a month is the equivalent of giving your customers a free loan for a up to four weeks every month. Invoice as close to the delivery of services or products as possible.
- Use payment incentives to encourage customers to pay early. Early payment discounts (typically in the 2-3% range) can be effective way to increase incoming cash to better fund expenses.
- Reevaluate your payment and reserve terms. Make sure you’re not paying your vendors earlier than you need to—negotiating longer terms wherever possible. Consolidating some of your spend is one way to secure more favorable terms. Paying too early unnecessarily leaks cash from your business. In addition, make sure any vendors holding a reserve against returns (common with some retail and ecommerce platforms like Walmart) are not doing so too aggressively, as this can allow them to hold back cash that you have rightfully earned through your sales efforts.
- Be smart about using credit card programs. Take advantage of cash-back and rewards points that can be used for purchases in lieu of cash.
How can we help?
Would you like more information about how Preferred CFO can help your business improve cash flow by making smarter financing decisions? Contact us today.
About the Author
About Troy Skabelund
Troy Skabelund has over 20 years’ experience as a CFO and financial consultant for organizations of all sizes and industries, including 12 years at the Walt Disney Company. A former revenue maximization consultant with extensive experience helping companies raise and protect capital, he specializes in enhancing cash flow, optimizing pricing strategy, finding creative financing solutions, and designing systems and incentive plans that help a business scale profitably with less pain and stress.
You may also be interested in…
3 Reasons you Need a Financial Forecast
If Your Company Doesn't Have a Financial Forecast, You're Wasting Time and Money Every company has goals. Where do you want your organization to be 5 years from now? 10 years? Most even have a general idea of the benchmarks you need to hit to get there—"By increasing...
Determining the Payback Period of a Business Investment
Whether implementing a new software system, adding office space, acquiring another company, or any other substantial investment, companies want to know how long it will take to recoup the money they spend on major purchases. The way to determine this is by calculating...
10 Steps to Prepare for Raising Capital
Finding funding for your business is a process that takes a lot of time and effort, especially during the startup phase. Many entrepreneurs fail in their first attempts at fundraising because they are poorly prepared. Others get themselves into trouble by choosing the...
How Can a Fractional CFO Help You Save Money?
In these days of economic challenges and changes, many companies struggle with uncertainty about the future, seeking tools and resources to best position their businesses for financial success. Often it can be beneficial to bring in a financial advisor who has...
What is a Capitalization Table and Why Does it Matter?
Capitalization tables, commonly called “cap tables,” are highly useful spreadsheets maintained by companies that have multiple owners or investors. Cap tables are especially important for private companies at startup and in the early stages of the enterprise. They...
Qualities of an Effective Profit & Loss Report
A Profit and Loss (P&L) Report, also called a Profit and Loss Statement, is a key financial document that details a company’s income and expenses over a specific period of time. This time period is typically a month, a quarter or a year. Depending on company needs...
What Is a Quality of Earnings Report?
When a business sale, acquisition, or major investment is contemplated, one important step in the due diligence process is the generation of a Quality of Earnings report, sometimes abbreviated as QOE. Even though a company may have strong financial statements, those...
What Is the Purpose of Accrual Accounting?
What Is the Purpose of Accrual Accounting? There are two methods of accounting: cash and accrual. In cash accounting, transactions are recorded when payment occurs. In the accrual method, revenues and expenses are matched and recorded at the time the good is delivered...
How Does a CFO Influence Strategic Decisions?
In every company, there are important decisions to be made on a daily basis. Some decisions are mundane and have only short-term consequences. Others are strategic and can affect the company’s performance and profits for years. Too often, these critical decisions are...