Maximize Cash Flow: How Factoring Can Work For You?

Posted by on Thursday, September 29th, 2016 in BLOG

Maximize Cash Flow: How Factoring Can Work For You?factoring clearwater CFO

As an outsourced CFO Firm, we often discuss the option of factoring with businesses who are looking to increase cash flow quickly. While this is one of the oldest types of financing for businesses, there is often a negative association with it as people often assume that it is a last-ditch effort by companies about to go under. This of course is a complete misconception.

Some businesses actually use factoring when they are first starting off, as with little or no credit history they may not be able to secure loans. This allows them to sell their invoices and get access to cash quickly.  Companies experiencing cash-flow problems or who have customers who do not pay on time, often choose factoring too. It allows companies to access their money quickly rather than having to wait the usual thirty to sixty days to receive payment. In fact, a business could receive their money in as little as 24 hours after selling an invoice to a factoring firm.

The Nuts & Bolts

Factoring is used as a cash management tool by many business owners. The process will generally start with a business making a sale and generating an invoice. A factoring company will then buy the invoice, or rather, buy the right to collect on the invoice. This is generally at a cost of 92 – 98% of the invoice amount. The company will pay 75 – 80% of the value of the invoice immediately.  With the balance paid when the payment of the invoice from the customer is received.

Factoring is based around the company’s customers and their ability to pay, rather than the company’s own financial situation. Therefore a company that has a record of customers being creditworthy, but can’t access funding in the form of loans, may be able to use this as an alternative source of finance.  With this said, it’s important to remember that this is not a loan. It is instead the sale of an invoice, which is effectively an asset.

The Cost

Factoring has long been seen as one of the most expensive forms of financing. However, this is not always strictly true. The discount rates involved with factoring may seem hefty in comparison to the interest rates offered by banks, but for companies who can’t qualify for a loan, factoring may be the only way for them to access cash when they need it. Factors also have other benefits that banks do not have. For example, factors can take over a great deal of the accounting work for a client, helping to conduct credit checks and providing insightful financial reports.  Many business owners prefer factoring to banks, as there is far less paperwork involved. It can also be a better solution than seeking funding from outside investors, who will often want to take a percentage of the business equity.

Not A Long Term Solution

Factoring is generally not a long-term solution however, and most companies will choose to factor for two years at most.  It also is not going to be a good fit for businesses that send out lots of small value invoices.  The fee’s involved will add up to a significant cost for the business. With that said, factoring can be a short-term solution that works well for many businesses. If you think factoring may be a good choice for you, talk to your accounting adviser. They should be able to refer you to a factor, based on what suits your needs and is customized to the business type and industry.

Best Results Require Good Planning

In conclusion, there are a number of pros and cons involved in this type of transaction.  The pros include it being a way of creating positive cash flow and access to cash quickly. It also allows for better financial planning because the business knows exactly when they will receive their cash.  In addition to factoring can help businesses to better understand their customers while at the same time avoiding bad debts.

The drawbacks of course include the cost associated with the fee for each invoice. It can also mean that the business effectively loses control of how they do business and how they manage debt.  The factoring company is now in direct contact with the businesses customers, rather than the business contacting them themselves.

Contact your accountant to discuss with them whether factoring would be a wise option to choose for your business.

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