How Small Businesses Avoid Financial Disaster

Small business owners and business managers typically struggle with collecting on accounts receivables. While many businesses can get away with requiring payment upfront on products or services delivered, other businesses cannot. When dealing with corporate clients, a small businessperson must generally agree to 50% upfront and 50% on completion of the work, in order to get the job. Other business managers have realized that if they offered financing to their clients, they could increase the number of sales that they can expect to receive.

Although extending credit to a business’ customers is good for business, most small- to medium- sized businesses cannot afford to float their customers’ payments indefinitely. In other cases, product or service suppliers do not have enough cash-on-hand at their end to float their customers’ payments for more than a week or two.

And then there are those times when the customer who received the credit from the supplier could not pay on time. Sometimes, those invoices remain unpaid for more than 90 days, and the supplier has to commit time to chase payment from the customer.

For Most, The Best Option Remains Unrealized

There is actually a different kind of financing out there that few people realize exists. It is called Invoice Factoring.

Invoice factoring brings a new twist to the challenge of financing businesses. Instead of having to go to a bank or an investor and lay out the records of the supplier, the supplier turns their invoices to a third-party financing company, also called a factoring company.

The invoice factoring company analyzes the credit of applicant business’ invoiced clients. The factoring company, based on the invoiced clients credit, will make a determination as to the likelihood of that client paying the invoice and charge a factoring rate based on this analysis.

When the supplier turns an invoice over to a factoring company, the factoring company will pay the supplier 70%-90% of the invoices’ face value, usually within 24 hours to seven days. The supplier will now have this money on hand for maintaining their operations.

The factoring company will take over the role of the accounts receivable department of the supplier. They will maintain contact with the client and ensure that the invoice will be paid in a timely manner.

Once the client makes payment in full, then the factoring company will extract their service fees for handling the invoice, which is called the invoice discount rate. Once the factoring company has received their fees, then it will send the remaining cash received to the supplier.

Planning Ahead To Prevent Financial Disasters

Most new business owners have the idea that the only way they can acquire cash they need to float client invoices or business growth is to go to a bank and ask for a business loan. Others think that the next best bet is angel investors.

But, the truth is that when dealing with banks, most will not talk to a company that has less than twelve months of operating records. Other banks require three years of operation before they consider giving the business a loan. And when they are willing to consider a loan application, they generally require one-to-three years of records to substantiate the loan.

Cost Benefits

Many small-, medium- and large-businesses consider the invoice factoring company to be a vital component of their business model.

When considering the cost of hiring people to maintain accounts receivables and collections, the cost of the factoring service is small in comparison to the alternative. Most factoring services only charge a invoice discount rate of 3%-5%, depending on the many factors that go into their analysis of an invoice.

One of the greatest benefits to the supplier is the ability to acquire cash immediately, to keep their business running smoothly while their customers delay payment. Two advantages are gained by getting partial cash payment upfront. First, the supplier can remain in good standing with its own creditors, because it is able to make its own payments on time.

If the supplier were to get a loan from a bank, the supplier would be looking at paying an interest rate in the range of 5%-15%, based on the credit rating of the supplier. These costs could easily exceed the cost of the factoring service in very short order.

One Less Worry

Business owners and managers have enough to worry about already, without having to worry about when and if a client will pay for services rendered.

The Small Business Factoring company can provide a product or service supplier with the capital they need to stay afloat, during those rough spells. Businesses, who employ factoring companies, have a more stable and predictable business model and tend to survive longer than businesses that do not.

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