What is fashion and apparel finance?

Fashion and apparel finance is a series of solutions designed to provide a textile or garment company with the working capital needed to run their business. Oftentimes, fashion companies sell their goods on credit, giving their clients 30 or 60 days to pay. In the meantime, they need funds to finance their day-to-day operations, make payroll and buy supplies. Fashion factoring companies provide capital to help resolve any cash flow issues.

Businesses may obtain working capital through invoice factoring, accounts receivable financing and purchase order financing. This article will describe each one in detail.

Factoring

Factoring is the sale of outstanding invoices, or accounts receivable, at a discount to a bank or a third-party financing company, known as a factoring company. Factoring can be an advantage to a fashion company in that it relies not on the trade credit profile of the fashion company but on that of the fashion company’s client. While this makes factoring a good alternative for companies that are just starting out, most of the companies Business Factors works with have a track record of sales. With a history of sales, it is also easier to set up a recurring factoring facility that a business can rely on to obtain working capital at any time.

Apparel factoring works in four simple steps:

• The apparel company provides the factor with the invoice that was sent to the company’s client (called the account debtor).
• The factor verifies the invoice and runs a credit check on the account debtor.
• The factor advances a portion of the outstanding amount to the apparel company. The advance rate for fashion and apparel businesses is usually between 65% and 85%. The factor also sets the discount rate, which is the cost of the factoring, along with any additional fees.
• When the account debtor pays the invoice, the factor returns the factoring client the reserve, minus the discount rate and any other fees.

There are two types of factoring:

• Recourse.
• Non-recourse

In recourse factoring, the apparel company agrees to buy back the invoice after a specified period of time if the client has not paid it. Alternatively, the apparel company can provide another invoice to make up for the unpaid one. This is the most common type of factoring. Factoring arrangements are usually structured as recourse factoring facilities.

In non-recourse factoring, the factor purchases the invoice outright, taking on the risk that it may not be paid. Business Factors offers non-recourse factoring and becomes responsible for collecting the invoices it factors, eliminating the need for back office operations.

Let’s take a look at an example.

• Factoring facility size: $800,000
• Advance rate: 70%, or $560,000
• Reserve: 30%, or $240,000
• Discount rate: 1.89% every 30 days
• Type of arrangement: Recourse
• Facility term: 6 months

This temporary arrangement is provided for an apparel company with seasonal cash flow needs. The apparel company puts up multiple outstanding invoices on which the factor advances 70%. The other 30% is kept in the reserve until the invoices are paid. The maximum size of the facility is $800,000. The amount that the business can draw on depends on the amount of the outstanding receivables it can offer the factor at any given moment. Once the invoices are paid off, they are replaced with new ones, or the amount of the facility drops. To use the facility, the apparel company pays 1.89% of the outstanding amount of the invoices every 30 days. The arrangement is recourse, meaning that if an invoice is not collected, the business must replace it with a new one or repay the advance.

Factoring facilities have a number of advantages:

• They offer a constructive response to the fickle nature and seasonality of the fashion and apparel industry. Traditional lenders are likely to base the amount of a credit facility on the receivables for the lowest point of the year. By comparison, factoring facilities may be tailored for use during the entire business cycle and may respond to the fact that an order can double or triple at a minute’s notice.
• They are easier to qualify for and are more flexible. Many apparel businesses are viewed as high-risk by lenders because their financial situation can quickly change based on consumer preferences, the state of the economy or the decisions of the end customer. In contrast, factoring decisions are based mostly on the trade credit quality of the end customer. Factoring facilities can be short-term to match the needs of the business.
• They can help protect apparel companies from bad debt, such as that associated with Barney’s recent bankruptcy (Vendors whose goods were delivered before the bankruptcy are set to recover less than 1% of their claim). After purchasing the invoices, Business Factors will continue monitoring the account debtor’s payment trends and will notify the client of any adverse developments, allowing it to make informed decisions about continuing the business relationship.
• Factoring facilities will not burden an apparel business with debt. Making scheduled interest payments on a bank loan can eat into a fashion business’s already unstable cash flow. As described on our Factoring FAQ page, the cost of factoring may not be higher than that of a line of credit, depending on the arrangement with the factor.

To get a quote or learn more about factoring, please contact one of our executives today. Business Factors works with companies with as little as $100,000 of EBITDA.

Asset-based lending

Loans can be long- or short-term. Their cost depends on several factors including:

Another way to finance a fashion and apparel business is asset-based lending. In asset-based lending (ABL), the amount of funds that can be advanced is determined by the value of a company’s assets. As described on our Asset-Based Lending page, the amount of an asset-based facility cannot exceed the so-called “borrowing base.” The base is calculated by taking the value of the eligible assets, such as inventory and accounts receivable, and applying a discount determined by the lender.

Here are some features of ABL:

• To qualify for ABL, the business must have been in operation for at least 6 months and have a minimum of $1 million in annual revenue.
• Unlike factoring, ABL relies more on the quality of collateral and the financial situation of the company that owns the assets to determine its ability to repay.
• Because ABL facilities rely on the quality of the underlying assets, lenders periodically audit a company’s books and review the collateral backing the facility.
• ABL facilities also typically come with covenants, which are clauses that limit certain actions by the company or require that it maintain a certain level of performance. These may include restrictions on acquisitions, limits on taking out additional debt or the requirement to maintain a certain level of EBITDA to interest expenses.
• ABL lenders can also advance funds against inventory and machinery and equipment. Work-in-progress is not usually included in the calculation of the borrowing base.

Below is an example of a borrowing base calculation:

The table above represents the collateral of a fashion business that sells clothes to a major U.S. retailer in a private-label arrangement. Its total assets as of the date of the borrowing base calculation are $800,000 and it obtains a credit line with a maximum borrowing capacity of $825,000. To determine how much it can actually borrow at any given moment, however, the lender calculates the advance rate, which is the maximum amount it is willing to extend against the eligible assets. That amount is $635,000 based on 80% advance rate for eligible accounts receivable, 50% on the inventory of finished goods and raw materials and 85% on the business’s brand-new machinery.

Since the borrowing base is measured periodically—such as quarterly or semi-annually—it is possible that the amount of credit available will decrease or increase, up to the $825,000 maximum for the facility. The advantage of an asset-based arrangement is that, typically, interest is only charged on the amount that is actually outstanding. If the rate of interest in this case were 12.5%, the business would pay $79,375 annually if the assets did not fluctuate in value throughout that year.

Purchase order financing

Purchase order (PO) financing is another way to finance apparel industry necessities. As described on our Purchase Order Financing page, in this type of financing the PO financing company pays a company’s supplier to ship an order to the final client.

A PO transaction in the fashion and apparel space could look as follows:

1. An apparel reseller gets a purchase order from a retailer.
2. A PO financing company verifies the order and agrees to cover all or a part of the reseller’s costs of fulfilling the order.
3. The PO financing company issues a letter of credit (L/C) to the reseller’s supplier or pays for the order directly.
4. The supplier ships the goods to the retailer.
5. The final client pays the PO financing company in the allotted time frame (such as 60 days).
6. The PO financing company substracts its fees and sends the reseller the remainder of the payment.

Alternatively, at step 5, when the reseller issues its invoice to the final client, it may factor the invoice to reduce or eliminate the time it has to wait for payment. The factor will then advance a certain amount against the invoice, minus any amount that it has paid to the supplier. Monetizing the invoice allows the reseller to reinvest the funds into another large order or use it for another working capital purpose.

For PO financing eligibility criteria, please refer to our Purchase Order Financing page.

Conclusion

Apparel financing is a series of solutions designed to help apparel and fashion companies obtain working capital to operate their businesses. Options include factoring, asset-based lending and purchase order (PO) financing.

Apparel factoring is the sale of outstanding accounts receivable (invoices) to a factoring company or a bank. Factoring relies mostly on the trade credit profile of the company’s clients, making it an option for businesses that are just starting out. However, to establish a factoring line, it is best to generate recurring sales. Most businesses Business Factors works with in the apparel space have been in business for several years.

Asset-based lending (ABL) is a type of secured lending that allows companies to borrow funds based on the value of their assets. ABL facilities can be backed by accounts receivable, inventory, machinery or real estate. Unlike factoring, they have more stringent eligibility requirements and can come with covenants, which are contractual clauses that limit certain actions by the business or require it to maintain a certain level of performance.

Finally, PO financing is a type of financing arrangement used by resellers where funds are extended to the supplier to cover the cost of a purchase order. PO financing is generally unavailable for first-time, guaranteed or consignment sales and transactions under $50,000 and with less than 20% margin for the reseller.

Contact one of our executives today to find the best alternative for your business.