For business owners facing cash flow problems, the situation can rapidly deteriorate. Perhaps you have plenty of sales, but all of your money is locked up in as-yet unpaid invoices. Maybe your business is very successful, but you cannot access your capital because your customers haven’t yet paid. Receivable factoring companies are financial institutes that allow you to get around that issue, obtain the cash you need to foster business success, and stop worrying.
First, an Introduction
Before we explain how to work with receivable factoring companies to benefit your business, we need to say a word or two on what factoring actually is. It’s not new debit. It’s not a loan or a line of credit. It’s not a cash advance against future earnings. It’s a way to gain access to money your business already has, that’s just not physically available yet.
Think about it this way. When you sell products or services to your clients, they’re invoiced for them. If you have net terms for your clients (30, 60 or 90 days), then you may go a month to three months between delivering the purchased products or services and the point that your customers actually pay for them. That money is yours – it’s just not available yet. It’s locked away in an invoice.
Receivable factoring companies transform an unpaid invoice into cash flow for your business. All the process really involves is selling an unpaid invoice to a factoring company. This is no different from selling any other asset your business owns – it is not taking out a loan. When you sell the invoice, the factoring company will give you an advance on the total (usually between 70 and 90% of the invoice’s value). Once your client pays the invoice, you’ll receive the balance of the invoice, less the factoring fee charged by the company.
So, receivable factoring companies give you the means to turn unpaid invoices into liquid capital without having to wait for your customers to pay. That’s of significant benefit to your business. How might you use that money? Really, the sky’s the limit here.
Using Receivable Factoring Companies
Receivable factoring companies can be used to obtain the cash you need for just about any use within your business. Some of the most common uses include the following:
- Making payroll
- Buying supplies
- Purchasing materials
- Buying new inventory
- Providing for day to day operating costs
However, there are many other ways that you could use that money.
Business growth requires capital. If all of yours is locked up in unpaid invoices, you might miss out on a growth opportunity that will never be repeated. For instance, you might be positioned to expand with a new location. You find an ideal building that’s priced very low (so low that it’s not going to be around for long).
If you use receivable factoring companies, you can sell an invoice and have the capital needed to purchase the property, outfit it to your needs, and expand your business. If you don’t use factoring, you’ll miss out on that property. Not only is this a missed opportunity, but it means that you’ll be forced to pay more for a potentially less desirable property once you’re flush with cash again.
Of course, there are many other potential examples of how receivable factoring companies could be used for business growth. It might not involve purchase a property at all. It could be buying new manufacturing equipment, new distribution solutions, expanded routes and more.
Taking on New Clients or Customers
For most B2B companies, taking on new clients and customers requires capital. You need the money in hand to manufacture products or deliver services, right? In the normal course of business, a single unpaid invoice could mean the difference between taking on a new customer and building profitability and being forced to turn down business.
For example, let’s say that you run a company that specialises in renovating old office buildings for new tenants. You provide an invaluable service, and you’re creating a reputation or outstanding results. You take on a client, purchase the materials and supplies needed to renovate the property, and pay your employees for the job. It gets completed and the customer is more than happy. You invoice them and then wait for payment.
Between the point that you invoice your client and payment is made, you’re approached by another potential customer for a renovation job. It’s a great fit, and you’re excited, but you don’t have the capital on hand to buy supplies or pay your employees until your previous client pays their invoice. In this instance, you might be forced to turn down that new client. That’s no way to run a successful business.
Not only does it mean that you’re unable to take on another job, and that you’re losing out on the income provided by that job, you’re setting a precedent and tarnishing your reputation. You’re telling other potential customers that you may or may not be able to serve their needs.
To Avoid Taking on New Debt
Now, you might have read the example above and thought to yourself, “I can think of a way around THAT problem.” The solution that probably came to mind was working with a bank to get a loan or line of credit. That’s definitely one way of handling that sort of situation, but it’s not the ideal solution, and here’s why: You’re doing nothing but taking on more debt, which means greater liability for your business.
Loans and lines of credit can be good business tools. In fact, they’re pretty much impossible to live without. However, there’s a very good argument to be made against saddling your company with yet more debt. How many creditors do you already owe? How many loans must you pay back? How much more liability can your company really handle?
With receivable factoring companies, you’re not borrowing money. This makes it fundamentally different from loans, lines of credit and merchant cash advances. You’re simply selling an asset your business already owns. You’re accessing capital that is already yours. Again, you don’t need to borrow anything. That’s a huge benefit for your business. Why borrow money when you already have capital available, locked in unpaid invoices?
To Avoid Expanding Staff
For small business owners, the prospect of hiring employees just to handle billing and collections can be daunting. That’s more money out of your business, plus additional benefits that you’ll need to pay for. The good news is that many receivable factoring companies can act as your billing department.
This allows you to avoid hiring anyone else, and also frees up your own time to focus on building your business, rather than on billing and administrative duties. Not all factoring companies offer this service, though, so you’ll need to choose your partner with care if this is an important benefit to you.
What You Need to Know about Receivable Factoring Companies
While the factoring process is actually pretty simple, finding a receivable factoring company to work with is not. There’s a lot that you’ll need to know in order to make an informed decision regarding your needs.
Advance Rates Vary: One of the most important things in your decision to factor should be the amount of your advance. Factoring companies provide between 70 and 90% of the invoice total as an advance, and most prefer larger invoice values. However, some companies might offer a lower percentage as an advance, or a higher percentage. You’ll need to consider the advance amount before signing any contract.
Factoring Fee: The factoring fee is taken out of the reserve, or the remainder of the invoice’s value after the advance. Generally, this can range from 1 to 5% of the invoice total. Again, that’s not set in stone, though. Some companies charge more than this, and if your customer isn’t particularly creditworthy, it can rise dramatically as the risk increases. Know how much you’ll be charged in the factoring fee prior to choosing a partner.
Can You Afford It: One thing that you need to understand when working with receivable factoring companies is that you will never earn back 100% of what your customer owes you. For companies that have a very fine line between cost and profit, this can mean that factoring is not a good option. If the total you receive back from the factoring company is less than what you need for profitability, this is not the best choice for you.
Contract Length: With most factoring companies, you’ll need to sign a contract. This might be a short-term agreement, or a long-term arrangement. If you cancel before the contract is up, you might be on the hook for steep penalties. Know the length of the contract before you sign, and make sure that any penalties for early termination are spelled out clearly. However, understand that some factoring companies do not require contracts, or can offer spot factoring if that’s a better fit. Some offer both contract and spot factoring options to fit different needs.
Your Customers Matter: When you deal with a bank or other conventional lender, they’re interested in your company’s credit. With receivable factoring companies, the focus is on your customers and their creditworthiness. If your customer has spotty history, or bad credit, you may not find a factor that will buy the invoice, or you may be forced to pay far more in fees than you would otherwise, which can eat into the value of factoring in the first place. It’s best to only sell invoices from clients that you know are going to pay, and that have solid credit histories.
Know the Difference between Recourse and Nonrecourse: You’ll learn two different terms that apply to types of receivable factoring companies – recourse and nonrecourse. While both types allow you to tap into capital locked away in your invoices, they’re not the same.
Recourse factoring is the more common of the two, but if your customer pays late or fails to pay the invoice, you’re responsible for repaying the advance given by the factoring company. Obviously, the best way around that is not to factor invoices from customers if there is any doubt at all of their ability to pay.
Nonrecourse factoring is less common, and more expensive, but the factoring company takes on all responsibility for unpaid invoices or late payments. Again, this type is more expensive, so it might not be the right fit for your needs depending on the value of the invoice and the amount you need to recoup to see a profit.
Find the Help You Need
As you can see from the information above, receivable factoring companies can provide you with the means to grow your business and enjoy financial stability. However, finding the right factor is not a simple matter. This is particularly true if you’ve never factored an invoice before.
In addition to ensuring that the receivable factoring companies you choose from are on the up and up, you’ll need to research fees and charges, customer service, the company’s reputation, how they communicate with your customers (and on what frequency), and more. There is also the fact that you’ll find specialised factoring companies and generalists out there. You also need to know whether the company offers any additional services, such as back office support, whether your account can be accessed online and more.
We can help you sort through your options. We have years of experience in connecting our clients with the right factoring company for their unique needs. We invite you to make use of a free consultation with one of our factoring specialists to learn more about factoring, determine your requirements, and find the right partner to ensure steady cash flow within your business.