Building a business is a group effort. Not only do businesses need funds to drive growth, they also need capital to fund their ongoing operations. Many come up with the necessary working capital by taking out business loans, but this often isn’t enough. Depending on your business’ size and financial health, loans might simply not be an option. The other traditional option, of course, is to turn to investors, who can provide financing in exchange for equity.
While this is an excellent solution in some cases, not every business can attract the investment it needs. Moreover, it also means giving up full ownership of your business. This can ultimately undermine your ability to realise your vision for your company. After all, investors have a significant amount of influence, and the motivation to use it to maximise their returns.
To come up with the capital they need to grow without taking on new investors, then, many businesses are turning to a combination of supply chain finance and invoice finance. These allow them to reduce their cash conversion cycle to zero, so they can fully finance their day-to-day operations. As a result, the working capital that was previously needed to fund production can be redirected to drive growth, and improve your business’ working capital position.
Understanding the cash conversion cycle
Businesses need to purchase supplies or labour, produce goods or services, and then deliver these to customers before issuing invoices and collecting payment. The cash conversion cycle (CCC) is the amount of time this entire process takes. More specifically, it’s the time it takes for a business to convert an initial investment into profit. After the payments are collected, the business can invest its capital again, starting the cycle over while keeping the excess as profit.
The shorter the cash conversion cycle, the more often the available capital can be reinvested in any set period of time, and the more profit can theoretically be generated. If the CCC is reduced to zero, the business can actually begin to pay for its inputs with the revenue generated by that same investment, because that investment won’t need to be paid for until after revenues are collected.
Using alternative finance to finance your operations
Supply chain finance and invoice finance allow businesses to functionally change when supplier payments are made and revenues are received. The goal in doing this is to reduce the CCC below zero, so that the business’ operations literally pay for themselves.
Extend payment terms with supply chain finance
Supply chain finance is a tool that allows businesses to finance supplier payments through a third party. Instead of paying out of its own funds, the business works with a financier, who pays the supplier when an invoice is due —or even earlier if desired. Then, up to 90 days later, the business issues the payment to the financier. Effectively, this extends the business’ supplier payment terms by 90 days. For businesses with a relatively fast CCC, this might already be enough to turn that investment into a profit, so they can simply use the money they earned to pay their suppliers. Those who need more time, however, can turn to invoice finance.
Get paid sooner with invoice finance
Invoice finance is a tool that allows businesses to collect payment on outstanding invoices before they become due. Instead of waiting for a client to pay, businesses can submit the invoice to a financier in exchange for immediate payment. The financier will then collect the payment from the client on their own, before paying out the remaining value of the invoice to the business. This means that businesses can be paid almost as soon as they issue an invoice to a client, rather than whenever that invoice is actually due.
If a supplier payment can be delayed longer than it takes a business to invoice the customer who ultimately buys the product or service produced, then invoice finance can be used to reduce the CCC the rest of the way to 0.
Clearing the way for future financing
Unlike more traditional financing, supply chain finance and invoice finance are off-balance sheet, meaning that they don’t create any new liabilities that need to be represented on the company’s balance sheet. This is important, because it gives your business a chance to grow without growing also growing your debts. The result is an improved debt to equity ratio, which makes it much easier to secure other financing options in the future. That might mean securing future loans to drive ongoing growth, or taking on investors from a position of relative strength. Whatever you decide to do with it, supply chain finance and invoice finance combined can objectively improve your business’ working capital position, and give you more and better options going forward.