Finance Roll

Most owners and entrepreneurs who have been in business for any length of time understand the power of financial leverage. This is especially important for manufacturing companies, which usually require a significant investment in equipment, raw materials and inventory before they can begin generating revenue.

The key to success for most manufacturers is to spend as little out-of-pocket money as possible on these expenses, thus preserving cash flow for the actual operations of the business. When used properly, financial leverage helps manufacturers do just this.

Two particular kinds of leverage can be especially beneficial for manufacturers: factoring and leasing. When used together, factoring and leasing provide a powerful one-two commercial financing punch.

Built on Cash Flow

"All businesses are built on cash flow and leverage, especially manufacturers," says Andrew Kaplan, the president of United Financial Group in Maitland, Fla., which specializes in equipment leasing. "It doesn't make sense for them to use all their cash to pay upfront for something that's going to generate income when they can lease it instead. Also, if they spend all their cash on equipment, there's nothing left over for materials, inventory, payroll, overhead, etc."

With leasing, you make a small down payment and then make monthly payments on the equipment, usually for five years or less. When the lease term is up, you can own the equipment by making a minimal buyout payment (often just one dollar). Also, because a lease is expensed, rather than capitalized, there are tax benefits to leasing compared to buying equipment.

"Leasing helps companies preserve cash and manage it more effectively," adds Steve Fix, a principal with LeaseSource, Inc., in Atlanta, Ga. "We've done equipment leasing for Fortune 500 companies that could write a check for a hundred grand without blinking an eye, but recognize the cash flow benefits leasing provides."

Going Hand in Hand

Like leasing, factoring can be an important cash flow management tool. In the same way that it's usually not smart to lay out cash to buy equipment, it often doesn't make sense to carry your accounts receivable, especially for slow-paying customers that may not pay for 60 to 90 days or longer.

By factoring accounts receivable, businesses accelerate their cash receipts drastically while also outsourcing credit and collections, thus freeing up owners to spend more time concentrating on core competencies. "Factoring and leasing go hand-in-hand," notes Fix.

For a manufacturing company, it might look something like this:

XYZ Manufacturing Co. needs to buy a new CNC machining center in order to take advantage of a new government contract. The cost of the machine is $100,000. While the company does have the cash to purchase this equipment outright, it could lease it instead-say, with a down payment of $5,000, and pay off the balance over the next five years.

At the same time, the company will need to purchase a large amount of raw inventory, prepare their shop for the new machine, and hire another employee to begin the new contract. Like many companies in similar situations, XYZ is "cash poor" but "work wealthy".

In addition, XYZ has outstanding accounts receivable totaling $75,000 from customers that typically pay in 60 to 90 days. By selling these invoices to a factoring company, it would receive up to 90 percent of the outstanding accounts receivable (or more than $67,000) within a matter of days to begin fulfilling its new government contract.

In this example, using factoring and leasing together could help XYZ Manufacturing turn a profitable new opportunity into reality quicker and more precisely than any conventional financing a bank could provide.

"When properly maintained, equipment will still be making money for a business for many years after it has been paid for," says Kaplan. "Every manufacturing business will eventually reach a threshold where it can't grow any more due to a lack of capacity. Factoring and leasing can help companies expand beyond this threshold."

Trucking is a good example of an industry that commonly uses factoring and leasing together, with powerful results. Trucks are usually leased, requiring a small down payment in order to conserve cash, and invoices are usually factored, which accelerates collections and provides the cash needed to keep trucks rolling.

Automatic Cash Flow

The bottom line is that it can be much easier to manage a business financially by using factoring and leasing together, because all you have to do is concentrate on your margin. Your cost to lease and operate a machine is fixed each month, along with your factoring cost, so it's easy to set prices that ensure the level of profitability you desire.

Meanwhile, you've created a scenario in which the business is virtually cash-flowing itself, and you can keep growing as fast as you can sell products. Need to buy a new machine? No problem, lease it. Need to collect receivables faster in order to keep the machine running? No problem, factor them.

In today's fast-paced business environment, where things change on a dime and opportunities often arise with little or no warning, companies must be nimble and flexible. Using factoring and leasing together can provide the powerful one-two commercial financing punch you need to succeed.