It is the dream of many entrepreneurial business owners; to get their product or service in every Wal-Mart, Costco, Sam’s Club, and Home Depot in America. For some, this dream becomes a nightmare on many levels and for so many reasons. Going into a relationship with a 1,000 lb customer with open eyes and a little knowledge will lesson the pain and increase the chances that the relationship can be good. Though there are so many things to learn and consider when doing business with a large retailer, this article is going to be limited to addressing the working capital requirements and various financial considerations a business should weigh before doing business with that “dream customer.”
The most important thing your business needs to consider is that accounts receivable (A/R) will grow very large, very fast. If your product is seasonal, the impact of A/R growth is much more complex.
Big Box retailers typically pay in 45 to 60 days, so a small business can become overwhelmed very quickly when the orders start coming in. Many businesses have folded over the issue of not having the working capital to finance the outstanding A/R. Going into the relationship, it is important to think about the following: 1) Do I have enough gross and net margin in the sale to make the risk and headaches worthwhile? 2) What is it going to cost me to finance the burgeoning A/R? 3) How will the “Deduct from Invoice” (DFI) fees impact collections and profit? 4) Does my contract or purchase order with the large big box retailer allow me to assign the proceeds of the contract (many don’t)? 5) How are warranty returns and regular returns handled?
Each of these questions could have entire books written about them, but just knowing what they are up front will be a good start. Start by asking the prospective customer for a sample of their vendor agreement and purchase order. Read them very carefully and if you don’t understand something in the sample documents, find someone who can help you understand the meaning of each and every term.
If your A/R are going to be substantial, you will need a financing source to allow you to turn your A/R into cash immediately, so it can be used to keep the inventory pipeline full. Although traditional bank lines of credit may be a possibility, they are usually too small for a small business selling to a large retailer. A/R financing or factoring is the next best thing. Picking a factor isn’t for the faint of heart. The factoring industry has become the mainstream way small businesses sell to large retailers across the entire world, so there really isn’t a stigma associated with selling your invoices to a factoring company.
There are thousands of good reputable factoring companies and banks who have factoring programs to choose from. Not all are created equally however and some are downright unscrupulous. As you talk to factoring companies about financing your growth, ask each one of them for their sample contract and completely understand all the fees that may (or may not) be charged to you for their services. My Company, Business Finance Solutions has relationships with many factors around the country and helps companies (at no charge to the client) when they have A/R financing needs. Business Finance Solutions has a Factoring Comparison Worksheet to help a client understand all the different terms and conditions and fees that a factor may charge. Feel free to download it and ask any factor making a proposal to complete the checklist for you. Be wary of any factoring company that will not fully disclose their sample contract and all terms. Do not sign any agreement you do not completely understand.
When your company uses a factor to assist with growth, the process involves you “selling” a customer’s invoice to the factor at a discounted rate. The factor advances you cash when the customer has accepted the goods or services at a rate of 75% to 95% of the gross amount of the invoice. The balance is held in reserve until the customer has paid and it is released back to you minus the factor’s fees. Factoring costs vary greatly depending on a number of criteria, such as the amount you factor on a monthly basis, the length of time it takes to get paid, and the perceived risk of your customer. The discount fees may vary from 1% to 3% of factored invoices for each 30 days. If you can estimate this cost as a percentage of sales and pass all or some of it on to your customer, you should do so.
Factoring doesn’t have to be prohibitively costly, especially when you plan your borrowing needs and are able to generate sales with larger gross and net margins than the cost of borrowing.