Trade Credit – also called Accounts Payable – is the single largest category of short-term credit and is especially crucial for small businesses. Trade credit is a customary part of doing business in most industries. It can be a contractual arrangement or an informal agreement that permits a business to pay its supplier over a given time period rather than upon delivery of the goods. A firm that does not qualify for credit from a financial institution may receive trade credit because an existing relationship has familiarized the seller with the creditworthiness of the customer. Since a large part of the supplier’s ability to accept delayed payments could be your credit worthiness (which is evidenced by your history of prompt payment), it is vital to pay debts in a timely manner. If you know you will be late on a payment, communicating this to your suppliers, along with a reasonable explanation and new date of payments, will help your favorable relationship continue.
The effect of trade credit can best be seen by example. Assume a firm makes average purchases of $2,000 a day on payment terms of net 30 days. On average, it will owe 30 times $2,000 – or $60,000 – to its suppliers. If its sales (and, consequently its purchases,) double, accounts payable will also double to $120,000. The firm will have automatically generated an additional $60,000 of financing through trade credit. Similarly, if the firm can negotiate extended terms of credit from 30 days to 40 days, accounts payable will expand from $60,000 to $80,000, which lengthens the average payment period and generates additional financing.
Finance companies assist businesses that are expanding and experiencing a cash shortage by purchasing the business’s accounts receivables. In factoring, the receivable is purchased at a discounted rate and the finance company pays the business immediately. There are two types of accounts receivable sales: recourse and non-recourse factoring. In a recourse transaction, the business retains part of the risk of customer default and is ultimately responsible for any shortfall. In a non-recourse situation, the finance company takes on all the rights and obligations of the receivable, including the risk of default by the customer.
Finance companies charge a fee that is usually 2 to 6 percent of the receivable. The calculation of this fee depends on the following variables: volume, size, and number of invoices; customers’ credit; location of the customers; and length of time of payment. Some companies charge an additional fee if the customer is late on payment, while others have one flat fee. Upon payment by the customer, the remaining value (10 to 30 percent), minus the fee, is sent to the business.
There are two methods of factoring, called traditional and spot. With traditional factoring, the finance company obtains the rights to an entire stream of receivables. This is best for companies with at least $1 million in annual sales. Spot factoring is the buying and selling of a single order or account. Businesses that only use factoring for a limited time or purpose, such as seasonal employees, often prefer the spot factoring method.
It is important to keep in mind that, unlike banking, there are not regulatory agencies overseeing the business practices of factoring companies. Most factors will provide prospective clients with a list of former and current clients as well as references from local lending institutions.
Factor Members of the NC Chapter of Commercial Finance Association
4600 Park Road, Suite 300
Charlotte, NC 28209
(704) 527-3550 ; (800) 897-2123
BB&T Factors Corporation
Market Square Tower
PO Box 310
High Point, NC 27261-0310
(336) 889-3355 x200
15800 John J. Delaney Drive, Suite 300
Charlotte, NC 28277
CIT Group / Commercial Services Inc.
PO Box 31307
Charlotte, NC 28231
GE Capital Small Business Finance Corporation
6100 Fairview Road, Suite 350
Charlotte, NC 28210
JTA Factors, Inc.
PO Box 6704
Greenville, SC 29606-6704
(828) 584-3199 or (800) 231-2757
8307 University Executive Park Drive, Suite 228
Charlotte, NC 28217
A typical lease involves three parties: the seller of equipment (vendor), the one who will use the equipment (lessee), and the leasing company (leasor). The leasing company buys the equipment from the vendor and leases it for a specified period of time to the business owner. Leases are best used by businesses that cannot afford the initial capital cost to buy the equipment. Usually nearly 100 percent of the cost of equipment can be financed, and no down payment is required.
There are also certain tax benefits to leasing which are dependent on the structure of the lease.
There are two types of leasing arrangements: capital and operating. In a capital lease, the lessee (the person taking possession of the property) assumes the obligation to purchase the equipment under lease. This is generally regarded as a form of medium-term debt financing. Both the value of the asset and the related debt are recorded on the lessee’s financial statements. Under an operating lease, the lessee pays a fixed monthly payment for a specified period of time, after which there exists no further obligation, and the leasor retains ownership of the equipment. Neither the asset nor the debt is recorded on the lessee’s financials.
Usually the leasing company will require small business owners to personally guarantee the lease. Typically, a leasing company requires that a business be in existence for two years and have a strong cash flow history. There are leasing companies that work with new businesses if the owner has strong personal resources and good personal credit. Terms range from short-term to long-term depending on the underlying asset.
For more information, please reference the Equipment Leasing Association (ELA)’s website at www.elaonline.com
NC Members of the ELA Dealing in Small Market Transactions
Bank of America Leasing and Capital Group
121 West Trade Street / NC1-005-15-01
Charlotte, NC 28255