Money is a constant headache for business owners, regardless of how successful your business is. That’s because business is competitive, and nobody can afford to let working capital sit around unused when it could be driving growth. Excess funds can always be used to expand production, expand marketing efforts, or develop new and more innovative products.
This means that cash flow issues, whether they arrive in the form of late payments, customer attrition, or unexpected expenses, will always arrive at a bad time. By the time a business needs to come up with additional cash, there usually isn’t time to submit a loan application, which can take weeks of months to process. While a traditional business loan makes perfect sense for funding a growth plan or other deliberate project, emergency short-term financing is better handled using off-balance sheet (OBS) financing.
OBS tools like invoice financing and supply chain finance allow you to take the stress out of everyday cash flow management by getting you the cash you need quickly and easily. More importantly, they can also boost growth, while keeping your business’ balance sheet clean.
What is off-balance sheet financing?
OBS financing is technically any kind of financing that doesn’t need to be listed on a balance sheet. All this means is that it doesn’t create any new liabilities. The best way to do this is to liquefy an existing asset, or to work with a financial institution to help defer payments on an existing liability. This allows businesses to cover costs without borrowing any funds.
Understanding why OBS financing sometimes gets bad press
As with lending, some forms of OBS financing are more reputable, and better for your business than others. For example, in the famous Enron scandal, the company hid its liabilities by creating partnerships, which borrowed funds on the company’s behalf. While that’s technically a type of OBS financing, it’s also clearly unwise in the same way that borrowing from a loan shark would be. Rather actually not taking on any liabilities, these kinds of unethical behaviours involve hiding liabilities that actually do exist.
Using OBS financing to manage cash flow and boost growth
Invoice financing and supply chain finance are two extremely useful types of OBS financing that independently allow businesses to cover short-term costs. Combined, they can be used to fully finance a business’ operations, greatly reducing the amount of dedicated working capital your business needs to invest in itself to sustain production.
To finance and invoice, a business exchanges an outstanding invoice to a financier for an up front payment, effectively getting an advance on a payment that it is already owed by a client. The financier then collect the payment from the client, before issuing any remaining funds to the business. In this way, the business can convert its non-liquid asset (the invoice) into cash that it can use to deal with its immediate needs.
Supply chain finance
Another way to free up working capital is to use supply chain finance, in which a financier issues an outstanding payment to a supplier on the business’ behalf. That same payment, now payable to the financier, then becomes due 90 days later. In this way, the payment on an existing liability is simply deferred by 90 days. The funds that would have been used for that payment can then be repurposed to deal with other costs during that time frame.
Either of these financing tools can be applied to free up short term funds to manage a cash flow issue, but together they can be used to finance the entire production process. Instead of investing existing working capital into supplies for production, businesses can instead use supply chain finance to defer supplier payments by up to 90 days. During that time, supplies can be processed into products and sold, and the resulting revenues can then be used for the original supplier payments.
Of course, revenues can’t always be collected at the point of sale. To avoid lengthy customer payment terms, the business can then simply use invoice finance to collect revenues immediately, ensuring that funds are always on hand when supplier payments are due. This allows businesses to free up the working capital that was previously tied up in their cash conversion cycle. Those funds can then be put to better use driving further growth for the business.
Off-balance sheet financing offers a variety of invaluable tools that allows businesses to manage cash flow on their own terms. This allows business owners to focus more of their time and capital on growth, while also making their business more attractive to investors and lenders.