There is nothing more frustrating to a business owner then having to turn away sales because they lack the cash flow to support them. For companies that sell products, this means not being able to replenish inventory in time to capitalize new opportunities. For companies in the service industry, this means not being able to pay the additional employees (or hours) to cover additional service requests. This problem is fairly common, especially for small and midsize businesses.
There are many things that can cause cash flow problems. The most common problem is a simple one: timing. The timing of the revenues does not match the timing of expenses. For many companies, expenses come before revenues. For example: a product supplier buys inventory (an expense), sells it on net 30 terms and then collects revenues 30 days later. Likewise, a staffing agency can place employees, who must be paid weekly but then bills the client on net 30 terms. Again, they wait 30 days before being able to collect the revenue. Unless the company has a capital reserve to operate the company and grow while waiting to be paid, it will run into problems.
If you are not able to get approved for bank financing, there is an alternative solution that can work better than a small business loan- especially if your challenge is that you cannot wait 30 days to 60 days to get paid by clients. It’s called factoring.
Factoring is very different from conventional business loans. With factoring, you get an advance for your outstanding invoices. This is the equivalent of a quick pay. This helps correct the timing problem between expenses and revenues and provides your business with the cash flow to support existing operations and new sales.
Most factoring companies don’t lend money; rather they buy the financial rights to your invoices. Their most important consideration is your clients’ ability to pay the invoices in a timely fashion. This makes invoice factoring accessible to companies who don’t have substantial assets but do have great clients. However, the credit quality of your invoices is not the only qualifying consideration of a factoring company. Your business must also be free of judgments, lawsuits and liens.
Factoring transactions tend to be structured as a sale with two installment payments. The first installment is usually 80% of the invoice value and is given to you as soon as the invoice is sold to the factoring company. The second installment, usually 20% less the financing fee, is given as soon as your client pays for the invoice. Financing fees are usually 1.5-3% of the invoice amount per month that it is outstanding.
Factoring is designed to solve the cash flow restrains generated the timing discrepancy between expenses and revenues.