Wholesale and distribution companies play a critical role in the global supply chain, bridging the gap between manufacturers and retailers. Economies of scale make these business models work, and so the capital outlay can be significant. The need to pay suppliers for large orders upfront while waiting weeks or even months for customers to settle invoices slows down cash flow, constraining liquidity and making it difficult for wholesalers to meet their own financial obligations, such as paying suppliers, maintaining inventory, and covering operational costs.
To manage these challenges, some wholesale and distribution companies use accounts receivable (AR) factoring, a flexible form of financing that provides immediate access to capital by leveraging outstanding invoices. In this article, we’ll explore how AR factoring can benefit wholesale and distribution companies, the specific cash flow issues these companies face, and alternative strategies for improving liquidity.
Cash Flow Challenges in Wholesale and Distribution
Wholesale and distribution companies often face several key cash flow challenges that can put pressure on their operations:
High Upfront Costs
As mentioned above, wholesalers and distributors rely heavily on economies of scale. Manufacturers don’t want to field a host of small orders from retailers needing hundreds of units. Wholesalers and distributors come into the picture, working in the middle to purchase thousands or tens of thousands of units to distribute them to their network of retailers. These large orders make wholesalers and distributors what they are, but they require significant upfront capital. Once inventory ties up that capital, it’s a time game to turn around and get that inventory turned around and out the door to retailers.
Long Payment Cycles
In the wholesale industry, it’s common for customers—retailers or other businesses—to request extended payment terms, such as 30, 60, or 90 days. These terms are beneficial for the retailers, because it allows them to potentially turnaround the inventory before even paying for it. However, while these longer terms are often necessary to remain competitive, they can create cash flow gaps, as wholesalers and distributors must still pay suppliers and operating expenses long before they receive payment. Tying up cash in inventory, and then waiting months for customers to pay, creates significant demands on liquidity.
Seasonal Demand
Many wholesale and distribution companies experience seasonal fluctuations in demand, which can make it difficult to maintain consistent cash flow throughout the year. During peak seasons, wholesalers may need to stock up on inventory, while during slower periods they may need to scale back or shift operational focus. Ramping up, pivoting, or slowing down again pressures cash flow and may require additional working capital.
Thin Margins
Wholesalers and distributors are middlemen in the supply chain, and so their margins can be pretty slim, which is why volume is so important—the greater the volume, the lower the cost per unit. With these slim margins, any delay in payments or cash flow disruptions can magnify financial challenges, making it harder to operate efficiently.
How Accounts Receivable Factoring Works
Accounts receivable factoring is a form of financing that can help wholesale and distribution companies address cash flow issues by converting unpaid invoices into immediate cash. Instead of waiting for customers to pay, wholesalers can sell their outstanding invoices to a factoring company at a discount and receive an advance on the invoice value.
Here’s how the process works:
- The wholesaler or distributer sells products to its customers and issues invoices with payment terms (e.g., 30, 60, or 90 days).
- The wholesaler then sells these unpaid invoices (accounts receivable) to a factoring company.
- The factor typically advances 80-90% of the invoice value upfront, and then waits for the customer to pay.
- When the customer pays the invoice, the factor remits the remaining balance to the wholesaler or distributer, minus a small fee for the service (typically falling between 2-5%).
For example, if a wholesaler issues a $100,000 invoice to a customer, the factoring company might advance $85,000. Once the customer pays the invoice, the factoring company releases the remaining $15,000, minus their service fee.
Benefits of AR Factoring for Wholesale and Distribution Companies
Improved Cash Flow
The primary advantage of factoring is immediate access to cash. Instead of waiting 30, 60, or 90 days for customers to pay, wholesalers receive most of the invoice value upfront, enabling them to cover day-to-day expenses, pay suppliers, and purchase more inventory without delay. Factoring is similar to offering customers a quick pay discount, except that the wholesaler doesn’t have to wait on the customer to take advantage of the discount—they just need to work with the factor.
No Debt Accumulation
Factoring is not a loan; it’s the sale of a financial asset (the invoice or accounts receivable). This means that wholesalers and distributors can access working capital without taking on additional debt or worrying about repayment schedules. The asset being sold (accounts receivable) repays itself. Moreover, since factoring does not increase liabilities, companies can maintain a healthier balance sheet.
Flexible and Scalable
AR factoring is scalable, since the amount of financing you can access largely depends on how much you can sell. As sales and invoices increase, so does accounts receivable and thus the amount of capital a company can access through factoring. This scalability makes it ideal for wholesalers or distributors experiencing rapid growth or seasonal fluctuations in demand.
Strengthening Vendor Relationships
With better cash flow, wholesalers and distributors can pay suppliers on time, potentially negotiating early payment discounts or better terms. The ability to build strong relationships within the supply chain is crucial for long-term success. Manufacturers prefer working with companies who can consistently place large orders and who can ensure timely payment, and factoring gives wholesalers and distributors access to the cash necessary.
Other Cash Flow Solutions for Wholesale and Distribution Companies
While AR factoring is an effective tool for managing cash flow, it’s not the only strategy available to wholesalers and distributors. Below are some additional options:
Optimizing Inventory Management
For a wholesaler or distributer, inventory is one of the largest expenses. So, effectively timing and regulating that expense could be enough to solve liquidity issues. Efficient inventory management can reduce the amount of cash tied up in stock and free up working capital to continue operations, or pursue new opportunities. Using data-driven inventory management systems can help wholesalers better predict demand, reduce overstock, and maintain optimal inventory levels to avoid cash flow bottlenecks. This is one of the first options a company should consider when facing cash flow challenges. If a company can optimize inventory management, they may not need external financing.
Extended Supplier Payment Terms
Wholesalers and distributors may be able to negotiate with suppliers to extend payment terms or offer financing options. Supplier financing can be a useful way to align cash outflows (payments to suppliers) with cash inflows (payments from customers), reducing the strain on cash flow. The drawback, however, is that it may require a strong existing relationship with the supplier. Additionally, extending payment terms with suppliers may put an unnecessary strain on the relationship or lead to price increases as the supplier compensates to maintain their own liquidity.
Offering Early Payment Discounts
On the flip side, another way to increase cash flow is to encourage faster payment from customers. Offering small discounts for early payments could encourage customers to pay more quickly and close the cash flow gap (for instance, offering a 2% discount for payment within 10 days). The benefit of this is that it doesn’t rely on external financing. However, it depends on the customer’s willingness to let go of their own liquid cash. Factoring functions similarly at a comparable cost, but doesn’t depend on the customer’s willingness to pay more quickly.
Trade Credit Insurance
Trade credit insurance (TCI, or accounts receivable insurance) protects businesses against the risk of non-payment from customers. If a customer defaults or delays payment because of insolvency, bankruptcy or even political upheaval, the insurance policy provides coverage for a portion of the outstanding invoice, potentially up to 85-95% of the invoice value. This can help wholesalers maintain healthy cash flow even when customers fail to pay on time.
Bank Lines of Credit
A line of credit from a bank provides flexible access to funds that can be drawn upon as needed. A bank line of credit will be more cost effective than factoring, but while this is a traditional option for managing short-term cash flow needs, sometimes it’s hard to qualify for the requested amount of capital. Typically factoring is only limited by the volume of receivables and the credit of the customer paying the receivable.
Inventory Financing
This type of financing allows wholesalers to borrow against the value of their inventory. It provides access to capital based on the inventory held in stock, enabling wholesalers to purchase more goods, expand their inventory, or meet other financial obligations while waiting for customer payments. The type of inventory is an enormous factor in the financing agreement. Inventory lenders generally prefer raw materials or finished products, as those are easier to resell in case of default.
Conclusion
Wholesale and distribution companies face unique cash flow challenges because of long payment cycles, high inventory costs, and seasonal fluctuations in demand. Accounts receivable factoring offers an effective solution by providing immediate cash advances on unpaid invoices, allowing wholesalers to meet their financial obligations and maintain steady operations.
However, while AR factoring is a great tool for improving liquidity, wholesalers and distributors should also consider other strategies such as optimizing inventory management, trade credit insurance, and supplier payment terms to keep cash flow healthy. By leveraging one or a combination of these tools and solutions, wholesale and distribution companies should be able to stabilize their cash flow, invest in growth, and remain competitive.
