Being an entrepreneur is one of the hardest journeys you’ll ever take as an individual. Starting your own company means you’ll have to encounter various challenges to be successful. Maintaining a positive cash flow happens to be one of them.
A lot of businesses fail before they fully take off because of problems with cash flow as a result of delayed payments. Depending on the nature of the business, clients tend to take a bit of time before paying their invoices. Some take a few weeks while others can go as long as three months.
This can be very frustrating especially in situations where frequent expenses continuously chip away at any cash reserves the business might have, leaving the business manager with no option but to prioritize various expenses over others.
While there are plenty of options you can explore to fund your business such as bank loans, small business administration loans, loans from non-bank lenders, or outside investors, none can quite compare to receivable factoring.
What Is Receivable Factoring
Receivable factoring is a process where a company sells its accounts receivable, or customer invoices, to a financial institution (known as a factor in this case). The factor will then collect payment on the unpaid invoice. This process is also referred to as accounts receivable financing or invoice factoring.
The factor then makes its money back by buying the invoice at a discount or deducting a factoring fee when they collect full payment on the receivables bought from the company. This factoring fee is usually a small percentage of the total value of the receivables factored. This rate, however, depends on the industry of the business factoring in its accounts, the creditworthiness of its customers, the sum of the factored receivables, and the duration of payment.
Another aspect that can affect the factoring fees worth pointing out is recourse and nonrecourse types of factoring. Depending on the factoring company involved, a business should have the option of choosing between either of the two.
With recourse factoring, companies often charge a lower rate. This is because if the client invoiced fails to fulfill the payment, the company is responsible for buying back the invoice from the factor.
With non-recourse factoring, the factor accepts full liability of the accounts receivable if the client fails to pay the invoice. Since the cash advance awarded to the client is not the total sum of the invoice, the factor also pays the remainder of the value of the invoice factored to the business.
As such, nonrecourse factoring is more costly since it involves the factor taking on a bigger financial risk.
Let’s take a closer look at some of the many benefits you can expect from receivable factoring.
It Is Very Business Friendly
Businesses of all sizes can use accounts receivable factoring. Unlike traditional lending, creating a profile account with a factoring company doesn’t take more than a few days.
To get a loan from a bank means a business should have an active account with the bank for long enough time for the bank to assess your account activity. The bank will also have to check your creditworthiness. But with receivable factoring, all that you need is a legitimate invoice. Factoring companies are also not concerned about your credit score since they’re collecting the payment from your client.
Cash Advances Are Processed Fast
Accounts receivables factoring allows business owners to convert invoices into the instant cash flow they need to keep their businesses running smoothly. Payments are often processed within 24 hours of the invoice being submitted.
Immediate funding will help the business pay for product expenses or staff salaries without having to wait for served clients to pay their invoices.
Keep in mind that it may take a bit longer if your company is registering with the factoring company for the first time. Any payments made after that are, however, processed swiftly. As such, it’s good business practice for small businesses to create profiles with a factoring company so that they may have their advances processed quickly when the need arises.
Your Credit Status Is Not a Problem
One very interesting benefit that most people are not aware of concerning accounts receivable factoring is that the credit status of the business applying for a cash advance will not bear any impact on its eligibility.
The factoring company gets its money back by collecting from the clients you invoice so your credit score is not necessary in the factoring process. Small businesses and startups usually don’t have a strong credit rating or the business history to get funding from traditional lenders, so this can be a great funding alternative for new businesses.
Factoring Can Help a Business Stay Afloat during Tough Economic Times
All companies, especially startups, experience cycles in business. Even great businesses have bad years and years when they performed exceptionally. But what defines a business more between those two situations is its capability to survive a downturn. The downturn could be due to an economic crunch, product-related lawsuits, or a rough patch for the entire industry because of an unforeseen related event.
During such rough times, you must have an understanding and reliable funding partner to help your business sustain its operations.
Traditional lenders are often very reluctant to lend money to businesses that are struggling. Most of them cut off a company’s credit as soon as they predict the company might be about to experience a downturn. This can make the situation even more unattractive.
Factoring companies however are not at all concerned with your creditworthiness but that of your client. That’s why even if a business has a terrible financial year, a factoring company can be a reliable source of funding that will stand with the business.
Improves the Creditworthiness of a Business
Instant funding from a factoring company will help a business improve its credit rating since it will have the money to pay for operating costs in good time, or even ahead of schedule.
This means that you won’t have to explore other options of alternative funding which are not really viable when you consider both time and overall cost. For instance, banks will want to see proof of owned assets that can serve as collateral while venture capitalists will ask to hold a certain percentage of equity ownership in the business.
Provide Plenty of Added Services
Apart from providing cash advances to business, invoice factoring companies also provide plenty of other additional services depending on the nature of the business.
When the factor takes over the entire accounts receivable portfolio, they assume other responsibilities such as debt follow-ups and collections as well as invoice processing. This means the business owner will not have to spend already limited business resources on scouting, hiring, and paying a team to perform that work.
Another very important advantage to this aspect of factoring is that if you’re considering taking on a new client, the factoring company can provide valuable insight into your potential client’s creditworthiness.
This information can help you avoid bad debt and eliminate any chances of bankruptcy by identifying clients with a reliable track record.
Helps the Owner Focus on Other Aspects of Business
By providing an easy and fast solution to the problem of cash flow, business owners and managers will have greater peace of mind. This can help you focus on increasing the productivity of other functions of business such as marketing, increasing sales, and acquiring new business.
By managing the debt collection side of the business, invoice factoring companies will save you a lot of time that you can dedicate to expanding your company’s margin of profitability. At the end of the day, it is one less thing to worry about in an increasingly competitive business environment.
It’s Your Money, Not a Loan
Perhaps the best part about factoring is that you don’t have to worry about paying back the cash advance received from factoring.
Paying back a loan can be very frustrating especially if you are struggling to make the money back within the set time frame so that it doesn’t damage your credit score. There’s also the aspect of high interest that you have to consider.
A factoring company will simply provide you with quick access to cash that you have already earned so you can funnel it back into your business for it to grow.
Cash Really Is King
A positive cash flow is like the blood that keeps the heart of your business pumping. Without cash, any profitable business can end up closing its doors because the amount of money flowing in is incomparable to the money flowing out.
All companies must have a positive cash flow so that they can make the right investment in the business if they want to stay competitive in their respective industries be it distribution, construction, or manufacturing.
With receivable factoring, companies of all sizes can maintain a positive cash flow by having access to fast cash advances that align with their business needs.
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