Small business owners primary concern is to generate cash flow as well as keep enough capital in the books to fund payroll, inventory, etc. This is a constant struggle for many business owners and dealing with cash flow shortages is a ever present fear lurking around. Traditional small business financing such as a line of credit or loans may not cut it and possibly out of reach. It’s at times like these that business owners will consider the option of accounts receivable financing. What we’ll be discussing here are a bit more about how this is structured as well as some pros and cons of this creative financing model.
Another word used in the industry to refer to accounts receivable financing is known as factoring and one of the oldest forms of commercial financing. The whole process involves the selling to a specialized financing or factoring company the outstanding invoices or “receivables” at a discount. The factoring company will take on the risk of these outstanding invoices with the intent of making the difference of what is owed to what they pay out. This benefits a small business as a quick influx of cash is possible instead of waiting months for the invoices to be paid.
Now the amount of discount is where the differences lie and is something each factoring company has their own proprietary methods to evaluate. Usually this is based upon the creditworthiness of the client which owes the bill as well as the amount of time that has passed. An invoice that is more than a month or two old is seen differently from a risk perspective than one that is current. Ninety day old invoices already pose significant risks and usually not taken on.
Be aware that this is a type of unsecured financing with no need of any collateral to secure it. There is no need give away an ownership of your business either so the quick cash may be absolutely necessary during lean times. There is also many cons to this, as with anything involving financing.
First there is a stigma as most customers will be informed of the factoring company receiving the money instead of you. Factoring can be more costly than traditional loans and the contract could be much longer than you’ve anticipated. Since a factor is not a debt collection agency, if the customer doesn’t pay, you will owe even more than you started. Despite all of this, accounts receivable financing clearly has a lot of positives that outweigh the negatives, depending on your situation.
As you can see, it’s not without good reason that accounts receivable financing is a popular option for business owners. Hopefully what you read here has given you a better picture of how you can implement it if necessary.