Consider Factoring Invoices
A major source of cash flow problems stems from waiting for payments made on credit. When invoices remain outstanding for 30,60,90 days or more, working capital becomes tight. that a business needs to meet payroll, take advantage of supplier discounts or purchase inventory. If you can’t make payroll, your employees, no matter how loyal they are, will NOT be happy. Factoring invoices allow businesses to meet these short term funding needs.
Customers that won’t pay their bills on time is not only frustrating, it can risk your business’ solvency. One of the most common reasons for business failures is poor cash flow management. A great way to improve cash flow is by factoring invoices, which converts a business’ credit sales into immediate cash.
Dealing with a customer who is late on payment is a delicate situation. Your customer may be delaying payment due to their own cash flow issues. They could be waiting for customer to pay them. There are a number of reasons why they may be having difficulty paying invoices. Unfortunately, there aren’t a lot of good options for you.
What is factoring?
If you’re wondering, what is factoring, here’s how it works. Instead of waiting for payment, a company sells its outstanding invoices to a third party (known as a factoring company or ‘factor’) for an upfront cash payment. This improved cash flow often goes towards working capital needs such as covering payroll, repayment of debt or any immediate need. The invoices are now paid to the factoring company, who is responsible for collecting payments.
Who Should Be Factoring Invoices?
Invoice Factoring is used by fast-growing, even start up businesses. These companies can’t afford to wait up to 90 days for repayment of their invoices, especially if these credit sales represent a large portion of their accounts receivable.Since a greater percentage of sales are made on credit to appease business customers, there is a need for working capital to successfully operate the business.
Further, start ups often have a very high cash burn rate. Factoring receivables provides the cash the company needs when they are bootstrapping through their infancy. The cause of many start ups is underestimating the capital required.
Many entrepreneurs often wear many hats-from handling collections to bookkeeping. But there are much better ways to handle these tasks. Consider using services like Quickbooks to handle your accounting and record-keeping. Many invoice factoring companies may require you to have these types of systems in place.
Poor credit rating
Businesses with very poor credit ratings, under 530, are not ‘bankable’. Traditional banks won’t lend to these businesses. When credit is tight and small businesses have a hard time getting credit, invoice factoring can really help. Remember, factoring is not a loan, it is an asset sale. So, the businesses get funding without incurring debt. Since the factoring companies have taken on the default risk, they are more interested in the credit rating of the invoiced customers anyway.
Invoice factoring companies will only purchase the invoices of business customers, not consumers. Factors also buy accounts receivables of certain organizations, such as government agencies. So factoring receivables is a viable option for so called-B2B companies, not B2C.
Cash flow problems and even negative net working capital become worse without access to traditional small business funding sources, such as loans or a business line of credit. That’s where invoice factoring can provide a big advantage-businesses receive funding without incurring debt.
Factoring invoices is often done by companies that operate in industries where payment delays are common. For example, businesses in the trucking industry, construction, printing and staffing industries are often clients of invoice factoring companies. These industries qualify because they have large projects that often have multiple layers of suppliers.
Businesses with seasonal needs, such as a toy manufacturer ramping up production for the holiday season. But, factoring in the retail business works best when there are not a lot of merchandise returns.
How Does Invoice Factoring Work?
Invoice factoring is pretty simple. A business experiences an increasing number of invoices and starts having cash flow problems. The business sells their invoices to an invoice factoring company, who now assume the collection duties and the default risk of the business’ customers (assuming non recourse factoring).
After the factor does some credit analysis on the account debtors, they advance the business a percentage of the eligible invoices, depending on the perceived credit risk. 75% to 90% of the invoice’s face value is pretty standard. Assume 80% as an advance in this example.
When the factor collects the remaining payment, they return the 20% reserve to the business minus their fee, typically 2%. If the payments were due within the first 30 days of invoicing (known as net 30) and payment was made to the factor, the 2% fee would apply. If the invoices were continually delinquent, the factoring company could also charge the business an interest rate for every day the funds were not recouped.
Isn’t Factoring Invoices Expensive?
Factoring accounts receivable is a bit expensive compared to other forms of invoice financing such as asset based lending or a business line of credit. If a factoring transaction was done every 30 day payment cycle for a year, you can see how the annual percentage rate, APR would look.
But accounts receivable factoring isn’t a loan so the comparisons are not really helpful. Further, the business is receiving services for the money, a collections department and credit bureau services. also, at the end of a fiscal year, the business would have sold an enormous amount of assets. If the business has monthly sales volume of $25,000, then the business would have sold $240,000 worth of assets assuming all invoices are factored with an 80% advance rate.