Working capital revolving lines of credit are specific loans that can help smaller businesses bridge the gap between when they pay for inventory and when their customers pay for their products.
Most companies must cope with a myriad of vendors and customers who are on different payment structures. Smaller companies typically have to pay upfront for their products, while more established companies that have more power will get the option of taking up to six months to pay for goods and services . Even if the percentage of cash generated by a company is high, the cash flow could be squeezed if customers have 60 days or longer to pay for products. This delay, even if it is 30 days, could put a company in a crunch after paying for employee salaries, benefits, leases and other expenses.
“We step in and bridge the gap,” said Danny Chan, a vice president and El Monte branch manager for East West Bank. “Working capital is what the bank issues as a line of credit to help the client bridge the gap between their capital needs, such as purchasing inventory from vendors and when their customers make a payment.”
While the terms and maturities vary from lender to lender, some financial institutions, such as East West Bank, require that working capital revolving lines of credit, also known as WC RLOC, are a minimum of $300,000 to $500,000, since it requires an annual renewal and a new analysis of the company’s current financial statements. However, the bank does not set a maximum amount and has provided greater amounts for larger companies.
Typically, a company seeks a WC RLOC of $1 million to $1.5 million for one or two year maturity. “This is a very specific product structured around trade finance,” Chan said. Companies are given discretionary when they receive these lines of credit, but the loans are based on their inventory levels.
One benefit is that companies typically only pay interest every month, compared to other loans where interest is calculated daily. These lines of credit require that the company pay down the principal amount once they receive a payment from their customer for the products.
The terms of lines of credit are different from term loans, which give a borrower a specific amount of money to use for their purposes, but is paid off over time, similar to a mortgage for purchasing real estate for the business. These lines of credit usually need to be renewed on an annual basis. Businesses with a good business plan and the ability to generate free cash flow are good candidates for renewals, Chan said.
“We are here to do cash flow lending and are not here to take over your business,” he said.
After being in the pharmacy business for more than a decade, Ken Thai, now the CEO of 986 Degrees Corporation, a group of Southern California-based specialty and compounding pharmacies, needed more capital to expand the footprint of the company, increase its hours and hire more employees. Over three years ago, the company sought additional working capital for its long-term care operation, which supplies pharmaceuticals to smaller medical facilities with elderly patients.
With the WC RLOC, the company was able to get more contracts to work with medical facilities, expand from 800 square feet to a maximum of 8,000 square feet within 10 years, and be fully staffed 24 hours a day and be open 365 days a week.
“In order to expand, we needed more cash flow, and the working capital revolving line of credit was a game changer,” Thai said. “It allowed us to be in a position where we could grow.”
In the pharmacy business, having ample inventory flow is critical. Third-party insurers and pharmacy benefit managers can often take two to three weeks to pay for drugs, which can leave a company in a lurch if they do not have adequate cash flow.
“There is that lag time, and you need cash flow to make sure your operations can stay open,” Thai said. “That’s why financing is even more important in the independent pharmacy world.”
Before the company received a line of credit, 986 Degrees was sometimes forced to taper its growth. “The line of credit allowed us to change the mindset of the business, hire more staff and create more infrastructure,” Thai said.
The line of credit has now been expanded, allowing the business to increase its revenue by 50-80 percent within a few years.
“Getting a loan can help a business leverage the cash flow they have,” he said. “I would not be able to grow the business to where it is today if I hadn't taken out that line of credit.”
After working with East West Bank for the past nine years to obtain SBA loans, bank loans and other lines of credit, Thai was confident this new line of credit would help his business prosper and boost its revenue and profit margins.
“They have been a huge partner,” said Thai, who opened his first pharmacy in 2006. “In many ways, if I didn't get a chance at receiving their support, I would have thought twice of continuing to expand the business.”
The company now has eight franchises in Southern California and Nevada, and is planning to open another pharmacy in Plano, Texas, in July and is working on adding two more locations in California.
“When you borrow money for a well-thought-out business opportunity, why not leverage that opportunity to help build that business,” Thai said. “You can do it faster and more efficiently when you take out a loan.”
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