An Example

Let's assume you buy on trade credit from your supplier and an account payable is created. Your supplier wants full payment in 30 days, however, you are selling inventory very fast, sell inventory a week later and are asking for full payment from your buyer in 7 days. You are now managing your conversion cycle. Consider, on day 1 you generate an accounts payable for 30 days from now. On day 7 you sell inventory and generate an accounts receivable, which your buyer will pay for in 7 days. What is your conversion cycle in case? -14 days, pretty good and you congratulate yourself. On day 15, after you receive payment, you are flush with cash and have a choice of reinvesting money or paying your supplier. What action you take will probably depend on a lot of factors, but as your supplier has provided you interest free cash for another 2 weeks, you may want to use it for those two weeks to generate greater returns; maybe you have outstanding credit you can pay down, you can buy additional inventory, or you may just want to generate interest returns.

Now consider that you also provide your buyers 30 days to pay you. On day 1 you generate an accounts payable for 30 days from now. On day 7 you sell inventory and generate an accounts receivable, which your buyer will pay for in 30 days. What is your conversion cycle in case? 7 days, not as good. You now have 7 days in your cycle during which you have repaid your supplier but will not receive payment for another 7 days from your buyer. You either need extra cash on hand or a credit line to support you for those 7 days.

What does this mean in terms of cash flow and your bottom line? If you have $1 million in annual sales and your receivables are outstanding an average of 60 days, that means you have $164,383 in outstanding receivables. Everyday extra day receivables are outstanding (e.g. 61 days vs. 60 days) represents an extra $2,740 that is not available to use elsewhere. If you need a credit line to support your receivables and you pay interest at 8% that represents $13,000 in annual interest charges (expenses) based on an average loan balance of $164,000.

So, as you can see, management of conversion cycle can have a large impact on business's cash flow and profitability. The management of your cash conversion cycle could determine whether you require a lending facility or not, or whether you can meet financial obligations.

Landlords can be a source of financing. It is not uncommon for a landlord to contribute dollars or rent concessions to development of a tenant’s space. For this loan, landlord may require a Percentage of Gross Sales Clause in lease as repayment. Extended vendor terms for purchase of product may provide short-term operating capital loans.

In event that additional credit strength is required, loan guarantors or borrowing someone’s credit may help borrower qualify for less expensive financing. Be flexible. Your final package may be comprised of several lending solutions

PRESENT A CLEAR AND UNDERSTANDABLE PROPOSAL Lenders need to know who you are personally, professionally and financially. The lender needs to evaluate Income Tax returns (Corporate and Personal), financial statements (income statement and balance sheet) and a cash flow projection. The balance sheet has to look a specific way. The Current Ratio should be at least 1:1, and Debt to Equity Ratio should be at least 4:1. Be specific as to how money is going to be used and how it will be paid back. Lenders want to know what is securing their debt. Lenders evaluate quality of collateral, and want to insure that it is adequate to secure debt in case of default. A secondary source of repayment is required prior to granting standard financing. The personal guarantee of borrower is often required. In some situations, a lender may seek secondary collateral. Secondary collateral is simply some other asset in which you have equity or ownership, i.e. equipment, property, inventory, notes. Business funding is not difficult if borrower is creative and realistic. Know how much money you need and how you are going to use it. Be prepared to defend your needs and anticipate lender’s questions. In event that a lender cannot grant your request, perhaps it is way a loan is packaged. Find a lender who is willing to make recommendations that will help you find financing. A good lender will tell you quickly if they can help you or not. If an intelligent and organized package is presented, a timely response is warranted