Tag Archives | working capital

Operating Cycle Definition

Operating Cycle Definition

The Operating cycle definition establishes how many days it takes to turn purchases of inventory into cash receipts from its eventual sale. It is also known as cash operating cycle, cash conversion cycle, or asset conversion cycle. Operating cycle has three components of payable turnover days, Inventory Turnover days and Accounts Receivable Turnover days. These come together to form the complete measurement of operating cycle days. The operating cycle formula and operating cycle analysis stems logically from these.

The payable turnover days are the period of time in which a company keeps track of how quickly they can pay off their financial obligations to suppliers. Inventory turnover is the ratio that indicates how many times a company sells and replaces their inventory over time. Usually, calculate this ratio by dividing the overall sales by the overall inventory. However, you can also calculate the ratio by dividing COGS by the average inventory. Finally, the accounts receivable turnover days is the period of time the company is evaluated on how fast they can receive payments for their sales. In conclusion, the operating cycle is complete when you put together all of these steps.

Operating Cycle Applications

The operating cycle concept indicates a company’s true liquidity. By tracking the historical record of the operating cycle of a company and comparing it to its peers in the same industry, it gives investors investment quality of a company. A short company operating cycle is preferable. This is because a company realizes its profits quickly. Thus, it allows a company to quickly acquire cash to use for reinvestment. A long business operating cycle means it takes longer time for a company to turn purchases into cash through sales.

In general, the shorter the cycle, the better a company is. Tie up less time capital in the business process. In other words, it is in a business’ best interest to shorten the business cycle over time. Try to shorten each of the three cycle sections by a small amount. The aggregate change that comes from the shortening of these sections can create a significant change in the overall business cycle. Thus, it can consequently lead to a more successful business.

operating cycle definition

See Also:
Operating Cycle Analysis

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What Does A Lender Want To Know?

See Also:
Relationship with Your Lender
Finding the Right Lender
The Dilemma of Financing a Start-up Company
Every Business has a Funding Source, Few have a Lender
Required Rate of Return
Venture Capital

What Does A Lender Want To Know?

I had a conversation with a prospect that needed working capital funding. He asked, “What does a lender want to know?” I hear this from every prospect I meet with. So, I gave my normal answer, “We will need personal and business financial statements, a completed application, detailed information on accounts receivable and inventory, and that is just the beginning.” After leaving the prospect, I realized not only did I not answer his question, but also I have never totally answered that question. I now know, the prospect is really asking me what information the lender is looking for so he can get the money.

When I answered this question in the past, I just gave a list of requirements and never explained why they were important to the lending decision process. This information is telling the company’s story to the lender. To start with, think of the financial statement you provide the lender as a score card. In the lender’s mind the more income you make the higher your score. As an example, the more runs a baseball team scores the more powerful the team is.

Tell Your Lender This

So after you tell the lender the score of your company, what else does a lender want to know? You should tell the lender about your company with the following information:

• How much money do you want to borrow? The lender needs this information to determine the potential to loan you money.

• Why do you want the money and how will it be used? Think of this one as if your child or family member asked to borrow money from you. I believe you would want to know what they were going to do with the money.

• What primary source will generate the funds to repay the loan? Some ways the lender might expect you to repay the loan are; selling a building, producing a product and selling the inventory, or increasing the profits of your business to generate cash flow.

• What is the secondary source of repayment? Amazingly, lenders want to be repaid as you would if you were loaning money. So they consider such things for their repayment as liquidating equipment or injecting additional capital from personal funds.

• How will the loan be secured (collateral)? The lender wants a security interest in whatever you are going to do with the money.

• Who will guarantee the loan? From the lender’s point of view, you must be 100% sure of your ability to repay the loan. And, you must be willing to put your personal assets on the line. Otherwise, they would be risking their job by making a potentially bad loan.

The better you tell your story the better your chances are of getting the money.

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

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What is Factoring Receivables

See Also:
Another Way To Look At Factoring
Accounting for Factored Receivables
Journal Entries for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
History of Factoring
How Factoring Can Make or Save Money
Factoring is Not for My Company
The What, When, and Where About Factoring

What Is Factoring Receivables?

Factoring receivables is the sale of accounts receivable for working capital purposes. A company will receive an initial advance, usually around 80% of the amount of an invoice when the invoice is purchased by the lender. When they collect the invoice, the lender pays the remaining 20% (less a fee) to the borrower.

There are two types of factoring conditions: 1) Factoring With Recourse and 2) Factoring Without Recourse. The term recourse refers to whether or not the shareholder(s) of the company are personally liable for the factored receivables in case the company’s client(s) don’t payback the invoiced amount. By far most factoring relationships are conditioned upon With Recourse terms. By shifting more of the risk onto the shareholder(s) of the company, the factoring lender is able to then charge lower fees.

Qualifying for Factoring

The first step in receiving factoring financing is to be pre-qualified by a factoring company or a bank’s factoring department. Typically this will entail an in-person meeting to review why the company is in need of factoring, as well as the provision of a company’s financial statements and supporting schedules (such as receivables and payables aging schedules) to document its operating history. They will also obtain information on the company’s customers.

A proposal for a factoring relationship will be created. This document will outline the proposed terms of the financing, including a facility limit, advance rate, discount fee schedule, repurchase provision, other fees, liens, process for notification of assignment, confirmation of receivables, and reporting requirements.

The proposal will be negotiated between the company and the representative(s) of the lender before being submitted to the loan committee of the lender for approval. Typically for proposed credit facilities of $1 million or more, lenders require a pre-funding audit of the prospective borrower.

Factoring Operations

In a factoring relationship, all payments collected for accounts receivable are to be sent to the lender, typically to a “lock-box” under their control. Customers are to be notified of this by a Notification of Assignment letter which will also contain the new payment instructions. Invoices sent by the borrower to their customers will be required to contain the new payment instructions as well.

The borrower decides what invoices to factor (“sell”) by notifying the lender, through the use of a document typically known as a “Schedule A” form. This document will list each individual invoice that needs to be factored. It will have details such as the customer name, invoice number, date, amount, and corresponding purchase order or reference number of the customer. The Schedule A is to be accompanied by documentation which substantiates that the goods or services have been provided to the customers. The lender will decide which invoices it will purchase and then will advance funds to the borrower. This advance is based upon an agreed upon advance rate. The rate is typically around 80%.

Discount Fee

Hold the amount not advanced to the borrower in reserve. Then as customers pay the invoices, release the amount held in reserve to the borrower, less a discount fee.

The discount fee is a percentage determined by a fee schedule. The factoring proposal lays out the fee schedule. The fee is a function of the time it takes for the customer to pay the invoice plus a variable component. The variable component is based upon the prime lending rate. The less time it takes to collect, the smaller the fee. Apply the discount fee to the amount of funds advanced to the borrower.

For those invoices not collected within 90 days of the invoice date, a repurchase provision will apply. This requires the borrower to buy back the invoice, along with a late payment fee (around 5%).

Factoring Lender Reports…..What They Give You

Purchases & Advances Report

The lender will provide a Purchases & Advances Report, which identifies the invoices purchased by the lender, along with the advance rate and amount of each invoice advanced to the borrower. This is typically available daily online.

Collections Report

Lenders also provide a Collections Report, which lists all payments received from a borrower’s customers. Remember that the lender will receive and process all payments for a borrower’s receivables. There are two formats for a Collections Report. Format A lists all payments received for a borrower’s receivables and identifies those which apply to non-factored invoices as well as factored invoices. The detail on a Format A report will include the following:

  • Invoice number
  • Invoice amount
  • Date payment received
  • Amount of the payment collected for each invoice

The second format of a Collections Report is Format D. On a Format D report, information about the reserve refund and discount fee paid out of the reserve for a given invoice is also provided.

Reserve Report

The Reserve Report provided by a lender details changes in the borrower’s reserve account. As invoices are paid and processed, the factoring lender will remit the remaining portion of the reserve. This is usually 20% of the leftover invoice, net of fees. Should there be any outstanding invoices that a customer has not paid back within the agreed upon time period, the factoring lender may require the company to buyback that invoice AND still charge a fee. This type of situation is called “with recourse” because the lender can force the company to “buy back” delinquent invoices.

The borrower is usually required to provide monthly financial statements, including A/R and A/P aging schedules, within 30 days of a month’s end.

If you want more ways to add value to your company, then download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

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Working Capital From Real Estate

Working Capital From Real Estate: An Asset Based Lending Solution to Cash Shortfalls and Opportunities

Let’s look at an example of working capital from real estate. Moreover, look at an asset based lending solution to cash shortfalls and opportunities

Problem

Many companies own the land and buildings necessary to conduct the day-to-day operations of their business. Oftentimes, this valuable asset is included in traditional bank financing packages as the cornerstone of the credit facility. As long as the business progresses as the bank deems appropriate, and all loan and debt service coverage covenants remain in compliance, the real estate loan will serve to anchor the lending relationship.

Companies and/or individuals may also own commercial real estate which may provide an income stream or conversely, suffer from under-utilization and needed development. These transactions are typically financed by the banking community as a “onetime” advance. That advance is conditioned for certain renewal requirements. In addition, additional funding is triggered by developmental thresholds that have to be met. Additionally, the investment opportunity associated with these properties may require balance sheet leverage beyond what the bank is willing to tolerate.

More often than not, an adverse business or personal event occurs which places the commercial property owner in a position where cash is critical but not readily available. Such situations could involve the following:

  • Delinquent taxes
  • Tax liens
  • Legal expenses
  • Divorce settlements
  • Environmental issues
  • Any number of cash draining, unpleasant scenarios

In the first two examples cited above, the traditional bank lending relationship may deteriorate because of economic or bank regulation issues beyond the control of the borrower. The real estate may have appreciated in value since the bank extended the original bank loan. However, further leverage of that equity is not available from the bank because of payment default, covenant compliance or regulation issues with which the bank has to contend. In the third example, the bank is oftentimes prohibited by internal policy and regulators from extending credit for the purpose of satisfying such obligations.

Solution

There are companies within the asset based lending community that can provide necessary funding to alleviate the cash shortfalls caused by the aforementioned problems. The asset based lender is more willing to look to the current appraised value of the real estate collateral to insure repayment as opposed to cash flow and financial statement strength. While loan to value percentages may be somewhat less than those allowed by the banking community, the liberal repayment terms and lack of covenant and compliance requirements afford the borrower the opportunity to alleviate the cash shortage and retain possession and control of the assets important to the well-being of the business and his livelihood. Some examples of the flexibility offered by an asset based real estate loan include the following:

  • Bridge loans
  • Interest only
  • Twenty-five year amortizations
  • Escrowed payment reserves

When cash is critical, and the options become limited, the appraisal value equity in commercial real estate can provide an asset based loan to alleviate the problem.

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

working capital from real estate
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See related articles: Mining the Balance Sheet for Working Capital

See Also:
Balance Sheet
Current Assets
Working Capital
Working Capital Analysis
Current Liabilities
How to collect accounts receivable
Factoring

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Working Capital Analysis

See Also:
Balance Sheet
How to collect accounts receivable
Factoring
Working Capital from Real Estate
Quick Ratio Analysis
Current Ratio Analysis
Financial Ratios

Working Capital Analysis Definition

Working capital (WC), also known as net working capital, indicates the total amount of liquid assets a company has available to run its business. In general, the more working capital, the less financial difficulties a company has.

Working Capital Analysis Formula

Use the following formula to calculate working capital:

WC = Current assetsCurrent liabilities

Working Capital Analysis Calculation

For example, a company has $10,000 in current assets and $8,000 in current liabilities. Look at the following formula to see the calculation.

Working capital = 10,000 – 8,000 = 2,000

Applications

Working capital measures a company’s operation efficiency and short-term financial health. For example, positive working capital shows that a company has enough funds to meet its short-term liabilities. In comparison, negative working capital shows that a company has trouble in meeting its short-term liabilities with its current assets.

Working capital provides very important information about the financial condition of a company for both investors and managements. For investors, it helps them gauge the ability for a company to get through difficult financial periods. Whereas, for management members, it helps them better foresee any financial difficulties that may arise. In conclusion, it is very important for a company to keep enough working capital to handle any unpredictable difficulties.

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

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Working Capital

What is Working Capital?

Formula: Current Assets – Current Liabilities = Working Capital

Working Capital (WC) is the difference between Current Assets versus Current Liabilities. Current Assets are those assets that will be turned into cash within one year, whereas Current Liabilities are those liabilities due within one year. This calculation represents the liquidity that a company has to meet its obligations coming due in the next 12 months. Though the amount should be positive, it can be a negative amount in times of distress.

Often used as a management tool, track the change in WC on a weekly basis. A company that is generating profits is usually increasing their WC. In comparison, declining profits often consume WC.

See Flash Report.

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

working capital
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See Also:
Balance Sheet
How to collect accounts receivable
Factoring
Quick Ratio Analysis
Current Ratio Analysis
Financial Ratios

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Mining the Balance Sheet for Working Capital

Mining the Balance Sheet for Working Capital

Let’s face it; there has been significant liquidity in the marketplace over the past couple of years. Debt and equity capital has been relatively easy to find and commercial banks have been very willing participants as capital providers. However, many of the commercial banks have admitted that this robust marketplace is a prolonged cycle and not a permanent or semi-permanent marketplace shift. By definition as a cycle, what goes up must come down.

Asset Based Lending Versus Commercial Bank Cash Flow Lending

Already, many of the commercial banks are starting to whisper about declining portfolio quality and tighter credit standards. This has been attributed to issues regarding the sub prime mortgage market, rising energy costs, and other economic factors. These issues have resulted in some companies experiencing a weaker balance sheet and a decline in cash flow results.

As banks start to tighten their credit standards, many companies may find they have less access or no access to working capital from commercial banks. Banks may elect not to renew certain loans that come due. Also, companies that have tripped a covenant or are in a technical default may find that their commercial bank is not as patient and has asked that the loan be refinanced.

So how can a company still access adequate working capital in a changing bank marketplace? One way is to mine the balance sheet assets through an asset based, working capital line of credit.

Comparison

Asset based lending is more common than ever and has become for many companies a more aggressive way to grow their business. Asset based lenders look beyond a company’s cash flow and balance sheet ratios to leverage the business assets for working capital purposes. They also provide an ease of doing business and typically have less restrictive operating covenants than commercial banks.

Commercial Banks

Commercial banks typically underwrite and grant credit by emphasizing in the following order:

1) Balance sheet strength/Cash flow

2) Management/Guarantors

3) Collateral/Assets

Asset Based Lenders

Asset based lenders assume there is some fundamental weakness to #1 above (at least by commercial bank standards) and flips the above equation upside down. The result is asset based lenders typically underwrite or grant credit by emphasizing in the following order:

1) Collateral/Assets

2) Management/Guarantors

3) Balance sheet strength/Cash flow

By emphasizing the value of a company’s assets as security and collateral for a working capital line of credit, an asset based lender has greater patience and tolerance for the bumps in the road and inconsistencies in the marketplace that many companies will face on a regular basis. Asset based lenders typically will provide a revolving line of credit against accounts receivables and inventory as collateral. Many asset based lenders will also provide term loans against equipment and possibly real estate.

Obviously, asset based lending is not the answer for every company’s need for working capital. It’s because not all companies generate these types of assets. Companies selling at retail or on cash terms don’t typically generate commercial accounts receivable which is the asset that most asset based lenders leverage as the base for a loan. However, if a company is involved in manufacturing, distribution and many of the service industries, then chances are they would generate the types of assets favored by asset based lenders.

Benefit of Asset Based Lending

The benefit of this type of lending is that the loan availability can grow as a company’s assets grow and, therefore, is not as restrictive as traditional commercial bank cash flow lending; especially in rapid growth situations. Since asset based lenders rely primarily on the company’s collateral versus its cash flow results, they embrace greater credit risk. They also accept inconsistent cash flow results versus commercial banks.

So as the marketplace changes and as commercial banks start to tighten up, remember that accessing adequate working capital may be as simple as mining the balance sheet through asset based lending.

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

Mining the Balance Sheet for Working Capital
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Categories of Banks
Working Capital from Real Estate

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