Look At Paper Assets To Improve Cash Flow
Accounts Receivable can be a source of immediate income when a company is not able to obtain a business loan or adequate line of credit from a bank
. It is often important for small businesses to be patient in collecting from larger companies in order to maintain a positive relationship. Often, small businesses have to wait an average of almost sixty days to collect even though their terms are net-thirty. Large companies know they have the clout to be able to extend the thirty-day cycle when smaller companies are eager to accommodate in order to insure additional orders.In order for a small business to maintain a good credit rating and to stay in operation, extension of the net-30 to clients creates a cash flow nightmare. That is particularly true when a business is growing. It is great to have additional sales but causes sleepless nights for the business owners wondering where they are going to get the funds to finance additional orders, payroll, accounts payable, taxes etc.
The cash flow crunch has caused a lot of businesses to think outside of the box by looking to alternative finance. When a business extends net-thirty on invoices, it is actually extending a thirty-day interest free loan. When the client takes sixty days to pay the invoice then the client benefits but it creates a problem for the business extending the credit terms.
It is difficult to finance new business with clients when the accounts receivable are not realized quickly enough to fill new orders. It causes a liquidity problem similar to farmers who are "land rich and cash poor." Their balance sheet looks great except for liquidity. There is very little bit of cash on hand.
Financing accounts receivable and purchase orders is an alternative to conventional financing. An advance goes out almost immediately from the factor after the invoice has been submitted. For example, when a business delivers a product or service in the amount of $100,000, the invoice can submited for an advance from a factor for $80,000. Most of the time, the advance will be in the business account within 24 hours. After the client pays for the invoice, the factor sends the remaining $20,000 minus the discount fee. If the fee were 2%, then the second installment would be $18,000. Thus, the cost of factoring would be $2,000.
While factoring is more expensive than a conventional loan, one has to consider the simplicity of factoring as compared to the time and complexity in applying for a bank loan. Also, protecting and building credit, saving on late fees, maintaining a positive relationship with suppliers, and being able to expedite an immediate advance for invoices submitted are reasons to consider factoring.
Flexibility is another consideration. If a business only wants to factor large accounts, it can do so. If there are certain business cycles when they have more volume and need to factor only during the peak of those cycles, that is also possible. In another scenario, when a business only needs to factor accounts that go past ten, twenty or thirty days, that is also an option. Cash flow management is best achieved through effective cash flow projections.
Growth is another consideration. Often, a business has to apply for additional funding from a bank when the business is experiencing growth. When a business has been approved for factoring, the debt-free factoring line of credit grows as a business grows and sales increase. There is no application for a larger volume of factoring. Once approved, the factor will automatically advance the additional amount as sales continue to increase.
Factoring should be considered a time-sensitive and temporary source of financing until the company is able to qualify for less expensive financing. There is no need to apply for an increase in funds.
In an effort to improve cash flow, an early-pay incentive such as 2-10-Net-30 is offered to improve the cash flow situation. A business offering an early-pay incentive can discontinue and offset part of the cost of factoring. Factoring in most cases is more reliable and predictable than determining who will take advantage of the early-pay incentive unless a pattern has been established previously to determine what clients would take the incentive. It is advantageous to know when the cash is going to be in the bank.
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