2 minute read

Not All Lines of Credit Are Created Equal


Revolving lines of credit to small businesses help fulfill a critical need for cash flow. They bridge the gap between the time services are completed or goods are shipped and the time payment is made for the resulting invoices. For most small business owners, this time gap can be challenging, especially since it is unpredictable and can leave the business at the mercy of its customers. For small businesses in the U.S., this time gap averages 50 days, although it varies by industry. Filling the gap with predictable cash flow is a critical requirement for businesses that are growing, as well as businesses that have opportunities for quick-pay and volume discounts.

A business’ need for short-term working capital financing can be measured by analyzing the volume of accounts receivable it carries as a percentage of total assets, and comparing that percentage with the anticipated growth rate of the business. ProfitStars® Lending Solutions studies this ratio semi-annually for more than two hundred industries and prepares the resulting Opportunity Score Report, utilizing raw data from First Research.

But the business’ dependence on short-term working capital is only one component of cash flow management; the other is a financing vehicle. Multiple options exist in the market today, from unsecured revolving lines to secured borrowing base lines, factoring relationships, and even hybrid funding approaches. In order to determine the best facility for the business, the owner should consider the seasonality of the need as well as the ease of use when drawing funds from the financing source. When financing accounts receivable, three factors can make a huge difference in the cash outflow from the financing vehicle: advance rate, line utilization, and line efficiency.

  1. Advance Rate

The advance rate is the first factor used to determine cash outflow to a business. For most traditional financing vehicles, the financing source will lend between 65 and 75% against accounts that are less than 90 days from invoice date. Other resources, such as factoring companies, may advance as much as 90% against the account value. For larger lines, the advance rate can make a huge difference in cash outflow to a business.

  1. Line Utilization

In 2016, the Commercial Finance Association reported that the average line utilization rate for asset based lending transactions was 40%. This percentage can vary widely though, from lines that are rarely used to the “evergreen” scenario, where the line is fully funded for an extended time.

  1. Line Utilization Efficiency

The third, and perhaps the most critical, factor in determining cash outflow is the more subjective measure of line utilization efficiency. For most revolving lines, it is up to the business owner or their controller to initiate a draw. The timing of draws has a large numerical impact on the volume of cash available from the line during the course of the year. Ideally, draws would be made as new sales occur and as opportunities for trade discounts become available. Some line structures, such as factoring and hybrid relationships, automate this process for business owners, releasing cash from the line each day based on sales from the previous business day. In effect, that approach provides the opportunity for 100% line utilization efficiency. It is impossible for business owners with a traditional revolving line to achieve that level of efficiency on their own. For most businesses, the line utilization efficiency percentage is more likely in the 40 – 60% range.

All three factors impact the amount of cash released over time through a working capital finance vehicle.  Recently, ProfitStars Lending Solutions developed a Line Utilization Calculator for the purpose of helping businesses and their financing partners determine the best course of action when seeking a revolving line. As always, the best facility for any given business will depend on their particular circumstances. For seasonal businesses, those with a low percentage of accounts receivable in relation to assets, and those that are simply not growing, a standard revolving line might do the trick. For businesses with growth and/or discount opportunities, a more structured facility would be best, in order to increase line utilization efficiency.

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