This article explains the concept of online receivables auction and its benefits. With the use of online receivables financing, companies have been able to accelerate its growth when they want and on their own terms. A key distinction between The Receivables Exchange and other, traditional forms of financing is that the Exchange gives sellers the opportunity to choose when and at what price to sell individual invoices. As a result, each company maintains control over its cash flow. Auctioning receivables can increase a company’s liquidity by cutting its day sales outstanding. In today’s financial climate, cash flow management strategies can mean the difference between the life and death of a company. Growth-oriented engineering firms are no longer judged by their short track record or lack of tangible collateral. Rather, because buyers judge the credit quality of the seller’s customers, sellers are able to leverage the strength of their best customers to increase their short-term liquidity at competitive rates.
Every business needs cash, to pay the rent, keep the lights on, meet the payroll. It also needs cash to grow.
A successful engineering service firm operating at or near optimum capacity needs cash to add professional staff if it is going to take on new business. It may also need cash to hire contractors to provide special services for a new project. It may need to buy or lease additional equipment.
There are times when opportunities come in faster than cash. No one wants to pass up opportunity, but gambling on cash flow is toying with financial disaster. So what are the options for a growing business—say, an engineering services firm?
There are conventional bank loans and lines of credit. Another option is factoring, which generally involves a contract to sell receivables at a discount to a financial institution that will then collect payments from customers. We believe that our company, The Receivables Exchange, offers a different option.
Since 2009, still under the cloud of economic recession, many engineering firms have had to cut back expenses and tighten their cash flow. One of our clients, Mason-Grey, an Atlanta based engineering services firm, was able to take on new opportunities and grow its business 65 percent in 2011.
In its early years, Mason-Grey easily funded its growth through internal cash flow. Terms of credit between the company and its customers remained simple, and costs were manageable. Engineering companies typically have a high proportion of total costs coming from salaries, and these are recurring costs. Because it was relying on cash flow alone, Mason-Grey constantly had to match revenues with salary obligations to ensure it did not overextend itself.
“Like most small companies we always struggled with cash flow,” says Mason-Grey's owner, Joe Reini. “I could have grown our book of business at a much faster rate if I wanted to, but that would have required some form of financing, which would entail adding more financial risk to my business. I was never comfortable with that approach.”
Advance rates range from 85 to 93 percent of the face value of receivables, and discount rates average between 0.5 and 1.5 percent.
The firm, which provides highly specialized engineering services to improve industrial process plant efficiencies, works with a roster of blue ribbon clients that depend on the company's services to ensure that their plants run smoothly. As Mason-Grey's clients began to feel the impact of the recession, demand for the firm's services began to slow, but opportunities for growth were still apparent.
In late 2008, Reini decided it was time to explore bank financing. He met several lenders and entered into negotiations with a bank regarding a line of credit that he could tap as needed to finance new business. The bank was only willing to extend him a line for a small proportion of the company's outstanding accounts receivable. This is common with engineering service companies that do not have tangible collateral to use as security for a loan. Reini was immediately turned off by the small size of the offered credit line, and the constraints it would impose on his company, including a personal guarantee.
Then in the spring of 2009, Mason-Grey had an opportunity to gain a large piece of new business, but Reini needed to act quickly to locate financing.
Reini had heard about The Receivables Exchange, an online marketplace for working capital. The Receivables Exchange is open to U.S. companies with a minimum of one year of operating history, at least $500,000 in annual revenue, and business-to-business or business-to-government receivables.
A company pays a one-time fee of $500 when it submits an application. There is a $10 posting fee for each auction of receivables. A transaction closing fee is subtracted from the advance amount at close, and there is an administration fee charged when funds are transferred through The Receivables Exchange's lockbox. Reini submitted an application and became a seller on the Exchange.
In its first auction, Mason-Grey's receivables were sold on Reini's terms and the funds wired into the company's bank account 24 hours later. After a few subsequent auctions, he was able to reduce the cost of capital by building a consistent transaction history, thereby improving his appeal to buyers. Buyers in The Receivables Exchange are a global network of accredited institutional investors. As their experience with Mason-Grey increased, their bids grew more competitive.
“Having access to working capital is an ongoing concern for most companies, both large and small,” Reini says. “With the use of online receivables financing we have been able to accelerate our growth when we want—on our terms. Today, if a client needed us to grow by 30 percent overnight, we can. I can add the staff, make them billable, and immediately turn those new hires into cash.”
A key distinction between The Receivables Exchange and other, traditional forms of financing is that the Exchange gives sellers the opportunity to choose when and at what price to sell individual invoices. As a result, each company maintains control over its cash flow.
Advance rates range from 85 to 93 percent of the face value of receivables, and discount rates average between 0.5 and 1.5 percent. The seller sets the limits of the minimum advance and maximum discount.
A mid-size company, for instance, may put $100,000 worth of receivables up for bid and ask for a minimum advance of $80,000, with a maximum discount of $2,000. Investors bid, and the winning offer may be an advance of $90,000 and a discount of $1,000.
The investor pays the advance directly to the seller. The Receivables Exchange settles the invoice with the original customer. The investor receives $91,000—the value of the advance plus the $1,000 discount—and the seller receives an additional $9,000.
According to Reini, the access to cash has let his firm take advantage of several significant opportunities over the past two years. Concerning the discount he says: “I view this as an incremental cost I incur to produce the additional revenue. For the invoices we sell on the Exchange, I simply build the discount at which I sell my receivables into my cost of goods sold because the costs are affordable and allow me to keep control of my working capital.”
Auctioning receivables has increased Mason-Grey's liquidity by cutting its days sales outstanding. Many companies are seeing similar results as they auction their accounts receivable.
In today's financial climate, cash flow management strategies can mean the difference between the life and death of a company. We believe that The Receivables Exchange offers a method that is particularly suited to technology service firms.
Growth-oriented engineering firms are no longer judged by their short track record or lack of tangible collateral. Rather, because buyers judge the credit quality of the seller's customers (who owe the receivables), sellers are able to leverage the strength of their best customers to increase their short-term liquidity at competitive rates.