- Fundamental operating cash benefits of revolver usage for inventory needs
- Leveraging your revolver as a negotiating tool
- Using your revolver as a vehicle to handle fluctuating demand
- The basics of advance rates
Inventory is a monster that eats cash. Feed it starvation rations.
The ability to access short term capital to fund inventories can preserve cash and smooth out significant spikes in cash requirements that could negatively affect business operations. Cash tied up in in-transit, raw material, work in progress (WIP), or unsold inventories is cash that can’t be deployed to areas of the business where it could generate stronger ROI. While many CFOs focus on the operational cash benefits of revolver usage, leveraging the revolver as tool for purchasing and addressing fluctuating demand are equally powerful.
Negotiate with Confidence
Nothing improves your purchasing power more than knowing exactly how much cash you have to spend. A revolver offers the ability to negotiate purchasing volume and timing with confidence. In addition, a revolver can help you create custom payment arrangements, take advantage of raw material price fluctuations, buy in bulk and act on one-time vendor discounts. This flexibility might not be available if you rely exclusively on your cash reserves, equity or other forms of higher priced debt.
A revolver offers the ability to negotiate purchasing volume and timing with confidence.
In order to maximize the benefits of a revolver, firms also need to make sure that the purchasing arm and finance function of their business align. Often the two groups function in silos, potentially losing this important value of inventory purchasing and finance.
Finally, if you have the capital resources to negotiate effectively and act decisively, you position your company as a better partner with the vendor. Whether it is reducing payable cycles, improving delivery standards or even opening the door to buy-back provisions of unused inventories, companies have used the “purchasing power” of the revolver to strengthen relationships that are mission critical to success.
Fluctuating Demand and Capital Availability
Economic cycles, ebbs and flows in demand and gains and losses of major customers are all issues that have a dramatic impact on inventory management. What’s unique about the revolver is its inherent ability to “move with you.” As you may know, revolver availability is determined by an “advance rate” percentage against your total amount of inventory. As those total amounts of inventory change, so can your capital availability.
Significant periods of growth could easily expand the size of your revolver when you need it most. Inventory demand is usually very high in those times when cash reserves are weakened as new receivables are en route. This is an especially strong feature of the revolver as it allows for companies to grow geographically, open new locations, expand into new product lines and act on other initiatives without unnecessary cash drain. Likewise, when demand wanes you may have much of your revolving credit facility go unused –which puts unnecessary risk on your lender and your bank relationship –so a reduction in overall availability may be in order.
The Basics of Advance Rates
The key to most effectively using a revolver to manage the inventory issues presented by fluctuating demand might be a better understanding of advance rates. There is no magic advance rate formula. All inventories are different and each lender understands those inventories differently.
Advance rates can range from 20% to 70% depending on their makeup.
Inventories are generally a higher risk form of collateral because they are less liquid than other assets (accounts receivable and equipment for example). Advance rates can range from 20% to 70% depending on the make - up of the inventory. WIP and raw material inventory may have little real value while finished product inventory may be easily resold. Inventory held with certain foreign locations may have no collateral value because of challenges perfecting liens with local governing law. Values can also vary state by state depending on if they allow the seller to have an automatic prior lien (also known as a purchase money security interest).
Applying a better understanding of advance rates combined with a more open conversation with your lender can maximize flexibility when demand is at its most volatile.
Ready to Help
At PNC, we combine a wider range of financial resources with a deeper understanding of your business to help you achieve your goals. To learn more about revolving lines of credit, please contact your Relationship Manager.