subject: How To Improve A Balance Sheet Without Increasing Debt [print this page] When a company is experiencing cash flow problems due to extending credit to clients, consideration should be given to improving the balance sheet by converting accounts receivable into cash. This is possible for companies that do business to business or business to government.
When a company offers net-30 days financing, it is as though the company has extended an interest free loan for thirty days. Often, their clients will stretch thirty days to forty-five, sixty or even ninety days. When the number or amount of invoices extends beyond on the ability of a company to operate efficiently or profitably, a company must be able to either get a commercial loan or to create liquidity by converting invoices into immediate cash.
When a company issues an invoice to another company or government agency, it becomes a company asset. A company can receive cash almost immediately after submitting an invoice to a factoring company. A percentage of the invoice is paid almost immediately. The remainder minus a discount fee is paid as soon as the client pays the invoice in full. It is similar to companies accepting payments from credit card companies except credit card companies pay for an invoice almost immediately and don't hold out a percentage for a reserve. So factoring involves two installments whereas credit card financing involves one installment to the business. Another difference is that factoring is business to business whereas credit card financing also includes consumers financing.
Factoring is a discounted purchase of an asset not subject to bank regulation. Factoring is not creating a debt. It is the sale of an asset. So it actually improves a balance sheet rather than adding debt. Factoring increases cash and decreases accounts receivable. The company does not give up company equity or assets other than the encumbrance of the accounts receivable.A factor mus be in the first collateral position to finance account receivable.
Some companies offer early pay incentives to encourage clients to pay early and get a discount. Factoring allows a company to discontinue those incentives. By being able to extend credit terms to clients, a company can be more competitive. Early discounts are often offered by suppliers for when a business is able to pay cash for materials. That offsets some of the cost of factoring by being able to utilize cash to buy materials.
Another consideration is that as the company grows, the amount of funds available also grows. The more invoices or the more the amount of invoices grows, the more financing provided by factoring. Once a factoring application has been accepted additional application need not be made for an increase in a line of credit in order to finance an increase in the number or amount of invoices.
By having funds available immediately for growth and not increasing debt, a company is able to improve the company's track record and credit. Once credit has been established, a company can once again find less expensive financing. Ultimately, a company should consider factoring a time sensitive and transitional way to finance the business. It is interesting that some Fortune-500 companies have used factoring to grow and transition into beneficiaries as creditworthy loan recipients The time value of money has to be a consideration where a company uses alternative financing. Whenb money is badly needed and is immediately available today, it is worth more than money in the future.
There are no restrictions for the use of the money received from factoring. Funds from factoring are unrestricted. Therefore, the funds can be used most effectively.
There is no need to turn down additional business due to a company extending credit to customers when factoring is available to convert invoices into cash. Factoring is a way of decreasing the gap between when an invoice is paid and when the company actually receives the money. Factoring might be considered an ATM for invoices.
Usually it only takes about 48 hours to be able to get an answer and subsequent proposal once a broker submits the application to the factoring company. Outstanding invoices can be financed in the initial funding of accounts receivable. However, only new invoices can be factored subsequently. A company does not have to submit all of its invoices. If a company has the ability to carry some accounts, it is not necessary to factor all of its invoices.
It is important to have a positive cash flow in order for a company to grow.
by: Russell Wardle
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