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Understanding Working Capital Financing Options For Franchises
One of the oldest sayings about starting and running a franchise is the answer to a common question; “What are the three most important aspects of a successful business?” and that answer is – “location, location, location.”
Which is great when you’re just starting out and want to make sure your business – your franchise – is located where most of your potential customers are (or where they’re most likely to find your business).
But after you find the perfect location, launch your business, and attract all those potential consumers to your business – then what? How do you ensure that your business can cater to them all – to keep them happy and satisfied with your products or services?
Starting a business in the perfect location is a great first start – but it’s only the beginning. Once your business is up and running, the hard work really begins.
A retail franchise must not only ensure that it has inventory on hand to meet customer needs, but must also constantly reinvent its inventory mix to meet the expectations of those same customers – keeping them coming back again and again.
A service franchise company must not only offer services that customers are willing to pay for (not just do it themselves), but must have the inventory and labor available to meet that demand, and must be flexible enough to service the individual needs of each customers at any level. of demand.
And the retail manufacturer must ensure a ready and constant supply of raw materials to meet the demand for his products – whether that demand is large or small.
Essentially, this means that the franchise must ensure that its business is flexible enough to overcome and eventually meet any and all customer needs.
But how this is done is by asking another question; “What are the three most important aspects is running successful business?” and the answer is – “working capital, working capital, working capital.”
What is working capital?
Equity is essentially the life blood of a business – any business, including franchises. If you compare your business to a vehicle (car, truck, motorcycle, large truck, etc.), it’s one thing to buy or own a car, it’s another thing to drive that vehicle down the road that gets you to point ” A ” to point “B”. To do this, you need a type of fuel – gas, diesel, electricity, biofuels, etc. Without this fuel, your vehicle will just sit and collect dust.
In business, to make your business run efficiently, you also need to add fuel to it – in the form of working capital – to get it from point “A” to point “B” or from start-up to growth or growth to expansions or expansions to success.
Working capital can take many forms, from the purchase (financing or acquisition) of inventory or raw materials to the acquisition or disposition of cash to pay for necessary labor, utilities, and even rent.
Imagine that a franchise (let’s call it “Tools and Machinery Anytime”) gets a new, large customer who wants to buy the services it offers (providing tools and machinery for large construction projects) worth $1 million, but doesn’t . they have enough of those tools and machines on hand for the job and can’t afford to get more now to complete the job – which would require about $100,000 in additional leased or leased equipment. The franchise cannot knowingly agree to this part and so this customer takes this million dollars elsewhere.
Or, a residential shade installation franchise is awarded a contract to install shades and shades in a newly constructed apartment complex that must be completed within the next 30 days, but will not be paid for the work for another 60 days after the apartment complex completes the final work. closing. However, the franchise must reject this $250,000 work because it does not have or cannot afford the work required to complete the installation within the next 30 days (since this new work will – by law – be required to be paid for before the 60-day apartment closing and subsequent service payment franchise).
Since the beginning of time, businesses have faced a lack of working capital that has essentially destroyed their businesses. These companies have done everything right up until this fateful point. They brought customers to their businesses and provided the products or services that those consumers wanted. However, due to poor working capital management, they get more customers than they can handle and are forced to turn away those patrons – not only losing that business, but creating a negative impression in the community that keeps other, new customers at bay (not to mention of a company that agrees to a job or an order and is unable to fulfill it and is consequently sued to death as a result).
How franchisees finance working capital needs
1) Traditional business loans. Banks have a great franchise financing program. But when it comes to working capital, the best product they offer is their revolving lines of credit – either secured by the company’s financial assets, such as accounts receivable or inventory, or unsecured, focused only on the company’s revenue or cash flow.
Either way, these commercial lines of credit work just like major credit cards (without the super high interest rates). This way, your business can establish a line of credit that it can draw on when needed, meet its working capital needs to complete a deal or sale, then use the proceeds from that order to repay the line and do it all over again as needed. – the key with lines of credit is that you only need to use them when you want to use them and only pay (interest) for what you use (in addition to the annual fee).
If your franchise can qualify, a bank line of credit is your best option for working capital today.
According to the SBA Office of Advocacy;
“How are franchises financed?
Existing employer franchises finance expansion using the same financial tools as other businesses, but start-up franchises are more likely to use a commercial bank loan. (37.8 percent of franchises, compared to 23.1 percent of all newly established employers, used a bank loan.)”
And it’s not just banks that provide these working capital choices, as some credit unions do, but the Small Business Administration (SBA) can also guarantee these lines of credit under its 7(a) loan program.
2) Alternative business lenders. Working capital is what most alternative lenders do—all to provide your franchise with the operating capital it needs, whether it’s from inventory, materials, labor, or whatever else is needed to run the business.
There are basically 3 types of alternative working capital loans:
Accounts receivable factoring: Many times, companies that issue invoices to their customers for payment must wait for those customers to pay – sometimes 30 days, 60 days or more. However, these same companies face their own capital challenges, such as having to pay employees, buy additional inventory or supplies, or start the next business or order—but they don’t have the money to do so until those invoiced customers , they don’t pay.
However, accounts receivable factoring companies will advance up to 90% of these unpaid invoice amounts so your business can move forward. Then, when your customers pay, you return the advance and keep the remaining 10% – minus the factoring fee.
Order financing: Remember our “Any Time Tools and Machines” franchise, which needed capital to acquire – let’s say on loan or lease – machines to complete a huge $1 million deal, but had no way to do it.
Well, that franchise could still sign that work order, then take that order to a PO financing company and get the $100,000 it needed – all 100% of what it needed to complete that deal.
After the job was done and the franchise was paid, it could reimburse the finance company for the $100,000 down payment and a small financing fee and not lose this very lucrative business.
Cash advances: Let’s say a retail franchise has already purchased inventory to sell in the upcoming summer season—it placed and paid for those orders months ago to ensure its suppliers fulfill orders on time.
However, a few days before the start of the summer season—after the company has already used up its current working capital allocation for its inventory, but before it has been able to sell any of those products for revenue—the new fade becomes (for its market) a national frenzy—it forces its competition to scramble to get products for his new fad.
However, without additional working capital or a way to obtain it, this company will lose out on this fade and profit that comes with the large impulse and emotional consumer buying that follows these frenzies.
Now, this franchise has no accounts receivable to factor, nor does it have purchase orders on hand, as its consumers do not make large upfront purchases.
But since the business earns revenue month to month – it can receive a cash advance for future sales – then use that advance to buy new Fade products.
Then, as it sells these products over the next few months, the finance company will simply receive micro-payments – usually daily – from those sales until the advance is paid in full – plus a small fee.
Here, a franchise could receive an advance against the amount of average monthly sales it earns from customer credit and debit card purchases (called business or merchant cash advances) or they could receive an advance against their overall monthly revenue averages (called loans or bank statement income Based Loans) – basically solves this franchise working capital problem in a matter of days.
3) Plow Back. If your only option is to use external financing for your business, then bank lines of credit or alternative financing are your best options.
However, you can – and should – manage your business and your revenue in such a way that you can fund your own working capital needs internally.
It simply works like this: Your franchise earns, say, $20,000 in peak revenue per month. However, after paying direct costs plus overhead for salaries, marketing and general administration costs, he has a net operating income (after taxes and interest) of say $7,000 to $7,000, which he would use to pay down debt, repay investors, or simply exit the business .
But if you also know that your business needs an extra $5,000 per month to cover future monthly working or operating capital needs – why not keep that amount from the $7,000 net income and put it back into the business. It’s much cheaper to do it this way – with your own money – than to face the additional cost of financing your business’s working capital needs.
The bottom line is that if you can’t get a line of credit from a bank or credit union, alternative loans can easily meet your needs—they’re faster to process and fund—but they come with higher interest and fees.
Location, location, location is the driving force that can make or break your franchise from a marketing standpoint – putting your business in the way of potential customers. But just because you have those customers patronizing your business, if you don’t have the operational resources to satisfy those customers – now and keep them coming back – then your location really doesn’t mean anything in the end.
So if you don’t want to waste time and destroy your franchise before it even has a chance to succeed, ask yourself this question; “What three things can I do now to ensure the long-term growth and success of my franchise?”
Then you can find your answer from this article – which is “share capital, working capital, working capital.”
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