1. Question: Financing accounts payable based on receivables
On large municipal construction contracts phased in over a period of months, what are the best options available to finance the accounts payable based on accounts receivable?
Answer
Municipal contracts are usually phased over a period of several weeks, if not several months. This may result in cash flow problems if cash inflows are not matched to cash outflows.
The ideal and most economical solution is to arrange for accounts receivable and accounts payable to phase in. However, such arrangements must be made through agreements reached with suppliers at the time of contract negotiation.
There are other ways of obtaining temporary financing to increase cash flow in a business.
- The company may ask the bank to increase its line of credit temporarily to cover major expenses related to the project.
- The company can also apply for a term loan to increase its working capital, with a fixed due date corresponding to the date set for receipt of final amounts payable. This enables the company to comply with its suppliers' preferred terms of payment, and sometimes even take advantage of discounts offered for early payments.
- Shareholders or third parties can inject funds into the business for the duration of the project.
- When the contract is signed, the company may ask for progressive payments prorated to work completed, enabling more prompt payment to suppliers.