Full Steam Ahead: How Factors Can Take Advantage of Increased Demand
Projections for the U.S. economy indicate the rest of 2021 will open up plenty of opportunities for working capital providers, and factors may be better positioned than most institutions to meet increasing demand. As Pat True of Jack Henry Lending explains, to capture the emerging market opportunity, factors will need to prioritize automation, efficiency and the right technology.
BY PAT TRUE, SENIOR RISK ANALYST, JACK HENRY LENDING
It’s been a rocky past 16 months for the U.S. economy, but things are starting to look up. In fact, The Conference Board is predicting more than 6% GDP growth for 2021, fueled by a strong 6.4% annualized growth rate in Q1/21, the influx of federal stimulus and pent-up consumer demand for getting out (and therefore, spending money). This includes a forecast of 8.6% growth in Q2/21 and 6.4% in Q3/21. Some economists even predict an annual growth forecast upwards of 7%.
To put these numbers in perspective, the last time the country experienced real GDP growth above 6% was nearly 40 years ago as it came out of the recession of the early ‘80s. Today’s recovery and expansion across a wide variety of industries is driving a rising need for short-term working capital finance, presenting a significant opportunity to those factors ready (and equipped with the right technology) to bridge the gaps.
Where We Are Today
The promising forecast for the remainder of 2021 is a marked shift from last year. In 2020, working capital finance demand was significantly lower than any other period since the great recession.
In addition to experiencing diminished customer demand for a wide range of products and services, many businesses were supported by an influx of cash from the government, with nearly $800 billion funded through the Paycheck Protection Program. Today, these trends are reversing to support steep economic expansion. PPP money and other stimulus programs have already begun to run their course, leaving small business owners to once again seek financing to fund new growth.
Because of most small businesses’ cash cycles, owners must use 40 to 60 cents of short-term working capital to generate each new $1 in gross revenue; it’s no wonder why so many small businesses struggle through periods of high growth. This presents an opportunity for factoring companies to step in and help to fund the recovery and expansion. While regulated lenders struggle to underwrite working capital loans for businesses with weaker balance sheets and income statements (which will likely be the norm during these unprecedented economic times), factors have the flexibility to take on loans traditional institutions can’t or won’t. In addition, this is an opportunity for factors to better diversify their portfolios, which was tough for many during the pandemic.
Brighter Days Ahead
When considering which industries are likely to drive demand, a careful eye should be given to those that carry accounts receivable and inventory. Why? Consider the asset structure of different types of small businesses. For example, a temporary staffing firm houses many receivables with few other assets to offer as collateral. On average, staffing company accounts receivable make up more than 45% of total assets, a substantial ratio. If a company with that structure has the potential to expand, it is very likely it will need a source of short-term working capital to make the opportunity a reality. These types of companies also are challenged to meet weekly or bi-weekly payroll expenditures despite customers often paying ton Net 30 terms.
Small trucking companies serve as another example; their accounts receivable average 32% of total assets. They also have a heavy reliance on accounts receivable, significant weekly cash demand for payroll, hefty fuel costs and short-term expenses. In the next two years, they also will face a high growth potential, as transportation in general is expected to see significant increase in demand. Factors should carefully monitor this segment.
It is likely that businesses in similar positions to staffing companies and small trucking companies will outstrip their cash cycles and soon. As a result, the market for short-term working capital will be robust. Those factors that have the appetite and relevant technology to manage an uptick in business will be well positioned to strengthen customer relationships and drive revenue.
Automate for Growth
It’s essential that growing factoring companies invest in modern technology and infrastructure that will allow them to manage increased demand with speed and accuracy while also reducing risk and delivering a seamless customer experience. A comprehensive portfolio management system can make all the difference, as it automates administrative functions and helps manage critical aspects of working capital financing such as invoice entry and verification, risk analysis, invoice delivery, trend analysis and credit checking. Perhaps most importantly, borrowers and lenders should have fully digital experiences.
If the pandemic taught us anything, it’s that people expect all processes to be quick, convenient and digital. Lending is no different. Successful factoring companies are embracing digitally optimized solutions that allow them to grow and scale with a digital footprint. Being able to provide borrowers and their customers with personalized, near-real-time account information anytime, anywhere is a compelling competitive differentiator. Those that fail to evolve will be left behind.
While the surge in business is a relief, there will be some turbulence in the transition. For example, are factoring companies prepared to manage a notable influx of purchases? Are debtors paying invoices slower than usual to maintain more liquid assets at hand? Transparency and timely data are critical for properly managing portfolios and staying on top of all the moving pieces. Prioritize technology that has sophisticated reporting functions, including aging reports to monitor skipped invoices, client analysis to evaluate purchases compared with collections and concentration reports that look at client/debtor relationships. These insights can reduce risk, boost efficiencies and enhance the overall portfolio management process.
Technology demand can vary between industries. Take the transportation sector, for example. This vertical is expected to be especially busy (and profitable) over the next 12 months. Verification is one of the most painful parts of transportation factoring; the process is notoriously time and resource intensive and wrought with repeat outreach to brokers and attempts to select the right invoices to verify, making it akin to picking a needle out of a haystack. Instead, lending platforms should provide direct access to transportation management system (TMS) data and automatic invoice verification, eliminating the need for cumbersome phone calls back and forth. This access also can proactively flag potentially problematic invoices. The automation can quickly and accurately identify areas of risk and streamline time-consuming, manual tasks while elevating the user experience.
Given the nature of recovering from the pandemic, expect to see a strong market for short-term working capital. By understanding the market trends, as well as the technology necessary to help optimize the process, factoring companies are well positioned to step up during this boom and help businesses access the cash they need to rebound. This will ultimately enable factors to win relationships and market share while playing an important role in supporting Main Street and the backbone of the U.S. economy.