Turning Negative To Positive Cash Flow With Factoring
Companies develop cash flow problems from carrying accounts receivable for 30 days or more
. It is often almost impossible for small companies to be a creditor and still be able to pay its own financial obligations.
Even though factoring is more expensive than conventional loans, the time-value of money needs to be taken into consideration. When a company is financially strapped or forced to operate less efficiently, money today is worth more than more money tomorrow. Likewise, more expensive funds today are worth more than the cost of turning away business or in paying bills after they have become past due.
Factoring is a way a business has of using paper assets to finance the business. A factor will usually pay about eighty-percent of an invoice within 24-48 hours after an invoice has been submitted. After the client has paid the invoice, the factor pays the reserve minus a discount fee. It is an opportunity for a business to pass the burden of carrying accounts receivable for 30 days or longer. Quite often, it actually takes closer to 60 days to collect on commercial and government accounts. Many large companies are late to pay as they are assured of their clout and counting on a continued relationship with their suppliers. Their supplier is wants to continue a relationship.
It is important for a company to find a broker who can match their business to a factor who knows something about their particular industry. For example, there are some factors that finance only medical accounts. Other factors will finance manufacturing. Yet others will specialize in construction. The amount advanced and the reserve percentage is determined by the type of industry a business is involved with. For example, a factor will usually advance 70% of an invoice to a construction company and the 30% reserve minus a discount after the invoice has been paid.
One of the favorable benefits of factoring is that the only collateral needed for factoring are the accounts receivable. If a company has debts with other institutions, a factor must be in a first collateral position on the accounts receivable. In order for a factor to have a first collateral position, it is often necessary for a bank or institute to subordinate. Often, it is in the best interest of a bank or loan institution to do so in order for the company to grow and meet financial demands and periodic payments.
The only time the funds are designated is when a company has past due tax obligations. Otherwise, the company is free to use the funds as deemed necessary. Factoring is technically the sale of assets rather than a loan. Thus, a business can consider factoring a debt-free line of credit.But the business is benefiting from the credit of its client rather than its own credit. Factoring does not adversely effect the balance sheet.
Once a company is set up for factoring, the amount available grows automatically as the company grows. The amount available grows along with the number and amount of invoices. It is not necessary to make application for a larger line of credit.
The application for factoring is quick and simple. Rather than looking at the credit of the company, factors look more closely at the creditworthiness of their clients. Their clients are ultimately going to be responsible for paying the invoices. So even when a business has less than desirable credit, there is still a possibility of getting factoring if the business shows potential. When a factor has received an application, the business will receive an answer within 48 hours. The aging accounts receivable and accounts payable are necessary for a factor to determine the eligibility of a company to employ invoice factoring or purchase order factoring. Other paperwork is required after acceptance of the application and the factor has made a proposal contingent upon receipt of the required documents.
Factoring should be considered transitional until a business can get into a position worthy of more conventional financing. Some Fortune-500 companies have used factoring as a means to solve cash flow problems until they could obtain funds from more conventional sources. Positive cash flow is necessary for a business to be able to operate efficiently regardless of what kind of financing it receives.
by: Russell Wardle
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