Small businesses often struggle with cash flow issues because they aren’t able to finance new projects until they get paid for their completed ones. Their ability to run their business is dependent upon other people’s payment schedules. Factoring receivables is a solution to this common small business challenge. Here are the main benefits of partnering with a reputable factoring company to improve your business’ cash flow.
What is Factoring?
Before we jump into the benefits of factoring, we need to explain what it is. Factoring is when you sell your outstanding invoices to a third party for a small fee. You get an advance of up to 90% right away and the balance owing is held as a reserve. The factoring company takes care of collecting the full amount from your customers. Once the customers pay the factoring company for the invoices, the reserve is released, and the balance owing is transferred to your business account. The factoring fee is deducted from either the advance or the reserve.
The single biggest benefit of factoring receivables is that you receive cash immediately to pay for whatever you need. While it’s not the full amount of the invoice, it’s usually a high amount, enough to get a new project underway. For example, if you have an invoice out to a customer for $10,000, but it doesn’t have to be paid for 60 days, you can sell it to a factoring company for up to 90% of the full amount.
In this case, you would receive $9,000 immediately from the factoring company, which you can then use to purchase materials for your next job, or for anything else you need (payroll, utilities, rent, etc.). The balance owing is held as a reserve amount until the invoice is paid in full. The factoring company then assumes responsibility for collecting the $10,000 from your customer. When they do, they release the reserve and transfer the balance owing to your business account. The factoring fee is deducted from either the advance or the reserve.
Depending on the industry, some companies can get an even higher advance amount. For example, trucking companies can qualify to receive advance payments up to 100% of the invoice amount.
Invoices as Collateral
Traditionally, small businesses might have to take out loans to cover their cash flow shortages, but they usually have to put up their assets as collateral for the loan. With factoring, your invoices are the collateral, so there’s no need to worry about losing your most valuable assets if your business begins to struggle. And, there’s no repayment of a loan, either. You get the money up front and the factoring company takes care of the rest.
Short-Term or Long-Term Solutions
You may only need to use factoring as a short-term solution to get your business back on track, or you might need to factor your receivables for longer because of a major project that is eating up your cash flow. Factoring companies can set up various plans to help your business through tough times, however long those might be.
This is particularly helpful if your company enters a term of rapid growth and you’re not able to keep up with the cash needed to fund new projects. Or, if your company is hit with an unexpected slowdown in sales, you can get the cash you need to keep the lights on until it picks back up.
Factoring receivables may not be the right financial solution for every company, but for many small businesses, it might be exactly what they need to get through a challenging time. The good news is that you can give it a try for a short time to see how it works for you.
Disclaimer: This content does not necessarily represent the views of IWB.