A manufacturer can be profitable and growing, and still experience cash flow pressure.

The reason is often timing.

Raw materials may need to be purchased weeks or months before a finished product is sold. Employees and suppliers need to be paid while products are being manufactured. Customers may then have 30-day, 60-day, or longer payment terms.

During that entire period, cash remains tied up in the operating cycle.

Seasonality can amplify the issue. So can a large new order.

Understanding where cash is being used and how long it takes to return to the business can help determine whether the solution is operational, financial or a combination of both.

For eligible manufacturers, SBA working-capital financing may provide another tool for managing these timing gaps and supporting growth.

Why profitable manufacturers can experience cash flow pressure

Profitability and liquidity measure different things.

Consider that you receive a significant new customer order. To fulfill it, you may need to:

• Purchase raw materials
• Increase production
• Add shifts or overtime
• Pay suppliers
• Hold work in process
• Complete and ship the order
• Invoice the customer
• Wait for payment

The order may ultimately be profitable. But you may need to finance nearly the entire production cycle before collecting the resulting revenue.

As order volume grows, so can the amount of cash required.

Where manufacturing cash gets tied up

Three areas deserve particular attention.

Inventory

Raw materials, work in process and finished goods all represent capital that has not yet returned to the business as cash.

Inventory requirements may increase ahead of:

• Seasonal demand
• Large contracts
• Expected price increases
• Supply chain concerns
• Expansion into new customers
• Increased production capacity

Accounts receivable

Revenue does not become available cash until customers pay.

You may experience rapid sales growth and rapidly increasing accounts receivable. Longer customer payment terms make a cash flow gap.

Production costs

Payroll, utilities, transportation, and supplier obligations continue regardless of when the customer pays.

Together, inventory, receivables, and production costs can create a significant working capital requirement.

Five questions to identify a working capital gap

1. Is revenue increasing faster than cash? Strong sales accompanied by declining cash balances can indicate that additional capital is being absorbed by inventory or receivables.
2. Is inventory increasing? Determine why. Growth-driven inventory may create a different financing need than obsolete or slow-moving inventory.
3. Are customers taking longer to pay? Even a modest change in collection time can have a meaningful impact on liquidity.
4. Is the company preparing for a large contract or seasonal peak? Calculate how much cash will be required before customer payments begin arriving.
5. Could the business afford to fulfill its largest potential order? This can be one of the most revealing questions. A company may have available production capacity but insufficient working capital to take advantage of a major opportunity.

Answering “yes” to one or more of these questions may signal a working capital gap.

How SBA financing can help with working capital

The SBA 7(a) program permits eligible financing for permanent working capital and inventory.

Manufacturers with recurring working capital needs may also want to understand the SBA 7(a) Working Capital Pilot, or WCP.

The WCP provides qualifying businesses with monitored lines of credit of up to $5 million.

Manufacturing is specifically identified by the SBA as one of the industries that may benefit from the program.

Depending on the financing structure, a WCP line may support eligible costs associated with contracts or projects or allow advances against eligible accounts receivable and inventory.

That makes it particularly relevant to certain manufacturing cash cycles.

Example: Financing a large customer order

Consider a manufacturer that typically generates $8 million in annual revenue.

The company wins a major order that will significantly increase production over the next six months.

The opportunity is attractive, but fulfilling the contract requires:

• $500,000 in additional raw materials
• $150,000 in additional labor and production expenses
• 60-day customer payment terms

The manufacturer may have enough production capacity to fulfill the order but not enough available cash to comfortably fund the entire cycle.

This is where working-capital financing can become part of the growth strategy.

Rather than using all available liquidity to fulfill the order, an appropriate working capital structure may help finance qualifying production costs while the company waits to collect customer payments.

Transaction-based versus asset-based working capital

The SBA Working Capital Pilot can generally address working capital needs through two structures.

Transaction-based financing

Transaction-based financing can support qualifying costs associated with specific contracts, projects, or orders.

This may be relevant when a manufacturer needs capital to execute a large customer contract.

Asset-based financing

An asset-based structure can provide advances against eligible accounts receivable and inventory.

This may be useful when working capital regularly becomes tied up in those assets as part of the company’s normal operating cycle.

The appropriate structure depends on the business, its financial reporting capabilities, collateral, operating cycle, and financing need.

Working capital should support the operating cycle

Financing does not solve every cash flow problem.

A company experiencing shrinking margins, obsolete inventory, or persistent operating losses may have issues that require a different response.

Working-capital financing is most useful when the financing structure matches a clearly understood business need. For example:

• Seasonal inventory build: Capital is needed before the selling season
• Large customer contract: Capital is needed to produce the order before payment
• Rapid growth: Inventory and receivables increase faster than internally generated cash
• Extended payment terms: The company must fund operations longer before collecting

Understanding why cash is constrained is the first step toward determining whether financing may help.

What information helps explain a working capital need?

Working capital financing often requires more detailed information about the company’s operating cycle. Useful information may include:

• Historical financial statements
• Current interim financial statements
• Accounts receivable aging
• Accounts payable aging
• Inventory reports
• Customer concentration
• Existing debt
• Backlog
• Purchase orders
• Customer contracts
• Cash flow projections
• Seasonal sales history

For the Working Capital Pilot specifically, the SBA notes the importance of timely and accurate financial reporting, including receivable, payable, and inventory information.

Don’t wait until cash is tight

Working capital planning is most valuable before liquidity becomes a problem.

A manufacturer preparing for a seasonal build, larger contract, new customer, or significant production increase can estimate the cash requirement in advance.

Start by asking: How much cash must leave the business before the additional revenue comes back in?

Then determine: How long will that cash remain tied up?

Those two answers can reveal whether existing liquidity is sufficient or whether working-capital financing should be explored.

For manufacturers in cyclical industries, access to the right type of capital can provide additional flexibility to manage normal operating cycles and pursue growth opportunities without relying entirely on cash reserves.

Sources

• U.S. Small Business Administration. “7(a) Loans”
• U.S. Small Business Administration. “7(a) Working Capital Pilot (WCP) Program Guide”
• U.S. Small Business Administration. “SBA’s Working Capital Pilot Program Delivers $150 Million to Support U.S. Manufacturing”