Although prolonged shutdowns and changes in consumer behavior have caused many businesses to use up cash reserves more quickly than usual, your company's current cash position might still amount to more than you think.
In fact, current liquidity can include not only the cash you have in the bank but also:
Lines of credit. A common rule of thumb is to have enough cash or credit available at all times to cover three to six months' worth of business expenses.
Sales for which you have not yet collected payment. A common way to calculate the amount of cash to be expected from sales is Days Sales Outstanding (DSO), a measure of the average number of days it takes your company to collect payment after a sale has been made. Shortening DSO can help increase liquidity.
Government stimulus efforts. Loans available from the Small Business Administration's Paycheck Protection Program is one example.
To determine your company's true cash position, subtract any outstanding debt from your available cash and credit. The final number is your company's current liquidity position.
But what happens if you don't have adequate cash on hand to see your company through an uncertain future?
This article is the first of a two-part series in which City National Bank experts discuss the need for companies to maintain liquidity and how they can access cash in the face of the pandemic.
Below are a few alternative courses of action for boosting your liquidity today.
These are two common tools for improving access to cash.
A business line of credit is a revolving loan that provides access to an agreed-upon amount of cash. It is what allows a business to meet short-term capital needs.
When you have an available line of credit, you can include the amount of available capital when figuring your current liquidity.
If your business has valuable assets, such as inventory, you may be able to leverage it to get an asset-based loan.
Usually, lenders will loan funds based on a percentage of the secured assets' value, such as 50 percent of the value of finished inventory or 70 percent of eligible receivables.
While these are not always available to early-stage companies and start-ups, another option is for the business owner to tap a personal home equity line of credit as an alternative.
Do your customers offer vendor finance programs? If so, this could be another way for you to boost cash flow.
“If a company sells to a high-quality buyer, such as BestBuy, Amazon or any other investment grade company, it often can join vendor finance programs that allow it to get paid faster, albeit at a slight discount to their original invoice value," said Brent Causey, global head of Supply Chain Finance at City National Bank.
“In these cases, credit cost is much closer to what the buyer would borrow at, making it extremely cost-effective for the company," Causey said.
If your customers don't offer a vendor finance program, invoice factoring is another option.
Typically, a factor purchases a large pool of receivables from your company at a rate of 50 to 85 percent of the invoice amount. The factor assumes the risk of nonpayment by a buyer, and the company gets paid right away.
This option usually costs 1 to 2 percent of total invoice value per month, Causey said.
Supply chain financing is another option, especially for companies that are finding instability in their suppliers' financial footing.
“In the past few months, large companies have discovered just how fragile their vendor supply chain can be, both physically and financially," Causey said. “Even if the large company is fiscally secure, its business still can be highly dependent on fragile suppliers."
Building a truly strategic supply chain is not easy, but it affords you the opportunity to understand the entire supplier ecosystem and how your relationships might impact potential results.
If you are able to finance your supply chain and approach the management process strategically, you won't risk depending too heavily on any single region, supplier or system that finds itself unable to supply needed goods and services in the future.
With supply chain financing, the bank pays the supplier early on the buyer's behalf, and the bank collects from the buyer on the terms it previously agreed to pay the supplier.
Many companies find this helpful. In times of stress, your vendors may value the ability to get paid in cash or on short terms more than they value higher prices, Causey said.
If that's the case, supply chain financing provides negotiating opportunities to reduce your cost of goods sold and help your vendors at the same time.
“In these changing times, where credit can be difficult to come by, alternative capital programs like these have seen significantly increased demand and can be a win-win for both buyers and suppliers ," Causey said.
As an alternative, City National Bank offers a receivables discounting program to clients who qualify.
With receivables discounting, City National Bank purchases receivables that are owed by approved, investment-grade buyers who have an adequate repayment history.
“Receivables are purchased at the bank's discretion, based on City National Bank's appetite for exposure to the buyer's credit," Causey said.
"We typically advance 90 percent to 100 percent of the value of the receivable. The discount rate is often somewhere between what the highly creditworthy buyer would borrow and the client's cost of funds, making it an attractive source of capital," he continued.
In the second part of our series, you'll find advice on options for earning higher yields to secure your company's liquid cash.
Meanwhile, keep up-to-date with the latest market news, innovation and shifting markets by signing up for City National Bank's newsletter here. Delivered weekly, straight to your inbox.
This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.