Last week in class, Entrepreneurship for Transitioning Warriors, we discussed the challenges of maintaining cash flow in your business. Here is an article about factoring which is one of several solutions to improving cash flow. Here Marco Terry, the managing director of Commercial Capital LLC, offers a thumbnail on factoring. Factoring is not for everyone as you'll see below, but for many veteran owned and military entrepreneurs it is a viable solution to preserving cash. The key for veteran owned businesses is to find the right cash flow solutions for you.
Terry writes--Most commercial sales happen on 30- to 60-day terms. These terms give your clients four to eight weeks to pay an invoice.
As a supplier, you can do little about this scenario. Clients expect you to give them terms as a condition of doing business with you.
However, selling on terms can hurt your cash flow. Many companies can’t afford to cover their business expenses while waiting for invoices to be paid. This cash flow problem only gets worse if your company is growing quickly.
How to solve the problem
A common way to solve this problem is to use business financing to cover the gap between invoicing and payment. Alternatives include lines of credit and business loans.
One option that is gaining some traction is to finance your accounts receivable. This option is commonly referred to as invoice factoring. Factoring allows you to monetize slow-paying invoices, providing immediate funds to cover company expenses and new investments.
How does invoice factoring work?
Factoring allows you to finance your invoices from commercially creditworthy clients. Basically, the factor finances the invoice by purchasing it and paying you for it in two installments. The first installment generally covers about 80 percent of the invoice. It is funded as soon as the work/product in the invoice is delivered. The remaining 20 percent, less the factor’s fee, is funded when the invoice is paid in full by the client. For a more detailed explanation, learn more.
Advantages of invoice factoring
The main advantage of factoring is that it can improve your cash flow — often quickly. When used correctly, factoring can help your company offer net payment terms and take on new clients.
Factoring is also comparatively easy to get. The most important requirement is that you work with commercially creditworthy clients. Most factoring lines can be deployed in about two weeks.
Disadvantages of invoice factoring
Like any solution, factoring does have some disadvantages. An important disadvantage is cost. Factoring is substantially more expensive than lines of credit or business loans. Consequently, factoring works best for companies that have a minimum profit margin of 15 percent.
Also, factoring is not completely invisible to your clients. The factor often contacts your clients to verify payment details and invoice accuracy. This contact can affect client relations if it is not managed correctly. Lastly, factoring is limited to solving a single problem: cash flow issues from slow-paying clients.
Will factoring work for you?
Determining whether factoring will work for you is not always simple. You should make this determination with the help of a qualified financial advisor, such as your CPA. Generally, your company will benefit from financing invoices if your clients are paying in 30 to 60 days and you need funds to pay ongoing business expenses (such as salaries, supplies, rent, etc.). Otherwise, you should consider a different solution.