Accounts Receivable Factoring - A Viable Cash-flow Solution for Small and Medium-Sized Enterprises
If you’re feeling the crunch of a cash-flow issue and have exhausted all possible avenues to find the cash needed to keep your business running, business account receivable factoring can be an excellent solution. You may not think it makes any sense to borrow money against what you already owe, but this strategy is surprisingly practical.
This post will explore why factoring is a viable option for SMEs and how it can help solve their problems with short-term cash flow so they can focus on taking care of their other responsibilities related to managing the long-term growth of their company.
What is factoring?
Account receivable factoring is a financial term for “borrowing money against your accounts receivables (the money you’re owed).” Your clients or customers are paying you with an IOU, not with cash. If you want to borrow money, it doesn’t make sense to borrow it against something that isn’t real. Factoring gives you the cash needed to run your business by using your receivables as the collateral. When you factor your accounts receivable, the factor buys your IOUs at a discount of anywhere between 1% and 80%. You get paid for the difference between what you collect and the purchase price paid by the factor. (1)
What makes factoring an attractive option to SME businesses?
Factoring offers SMEs a quick, simple solution to their cash flow problems. In fact, it’s so easy they may not even realize they have an issue until they talk with a factoring expert to find out how much money they could potentially save by using this strategy. Factoring is also profitable for the factor, but that’s not its main purpose. The main purpose of this practice is to get immediate cash flow relief for debtors who are struggling through a tough economic time or who simply need some cash quickly.
There are many factors that contribute to SME business debt, but it’s not the only one. Business owners with good credit profiles and healthy cash flows often find themselves in need of more cash than they can generate by operating as if they had a steady basis for their operations. While going out and looking for loans is often necessary, it’s not a solution that is always practical when you’re already drowning in bad credit and borrowed money. (2)
Faced with the possibility of having no choice but to seek outside funding, most financial experts recommend turning to factoring companies instead of banks or other lenders because most banks won’t offer you the low rates that factoring companies do. (3)
According to the World Factoring Association, the use of factoring as a financing tool has been on the rise. In 2003, factoring companies accounted for $1.6 billion in sales, compared to $10 billion in 2005 and $13 billion in 2009 (including 2008). (4)
The average transaction size for factoring companies is $200,000, but these can range anywhere from a few thousand dollars to several million dollars. It’s not just small businesses that turn to factoring companies today; large corporations are beginning to use this strategy as well.
Getting to the root of the problem
The main reason businesses experience cash flow problems is because they don’t have a plan for their business. According to an article in Smart Business, a publication from American Express, many SMEs don’t plan for their growth and end up spending too much money too fast. (5) That’s why it’s necessary to develop a plan that details all your spending habits and all the money you expect to come in over the next 12 months.
The best part about factoring is that it can be used to make up any shortfall in cash flow. The factor will take your receivables as collateral for the factored amount. While this cash can come in useful if you’re able to collect on your receivables and pay off the factoring company, it isn’t a source of new business income if you don’t use the funds as intended. It will be gone either way, but the quicker you get these funds, the quicker you can start making money again.
How could factoring help a small business?
Factoring can be an excellent short-term financial solution for businesses that have been struggling to keep their heads above water financially. Factoring companies are willing to lend money against your receivables at rates that far exceed bank financing. (6) Factoring can provide immediate relief to SME businesses that are suffering from cash flow problems.
For example, say you have 20 customers who owe you $50,000 – a total of $1,000 each month. If factoring companies were paying 6% every 30 days on these accounts, that would be a rate of $375 per month in advance for all the money you’d need to collect from the small business owners – about $10 more than you need now to keep your business running.
Using factoring would give you all the cash you need to pay your bills, get back on track and continue to collect your receivables. The factoring company would then have until the end of 30 days to collect the remaining $100,000 so that it could keep the money you had already repaid. This strategy provides businesses with immediate relief while collecting their money in chunks every 30 days instead of all at once.
If a small business could plan its growth around these chunks, it could use this cash flow relief as an important lever for growth. It could set up a 30-day marketing campaign at different times during the year and plan for how it’s going to spend the proceeds from this campaign.
The bottom line
Factoring is a smart and easy way for SME businesses to overcome their cash flow problems without taking on new debt. It’s a strategy that can be used for many different types of businesses. While factoring companies are willing to lend up to 100% of the receivables, you might find yourself turning to banks and credit unions if you have good credit scores and healthy cash flows. If you feel like you have a strong plan for your business, it might make sense to consider factoring companies instead. You won’t need extra capital because they will factor against your receivables at rates that are higher than what consumers typically pay when they pay with personal or home equity loans.
Conclusion
Factoring is an essential resource that SMEs need to learn more about. It’s a tool that can help businesses thrive in any economic climate. When you factor your receivables, you are using your credit to get cash quickly when times are tough. Factoring can provide relief to the underbanked by getting them the cash they need without their having to turn to payday lenders or other sources of high-interest loans.
One important thing for business owners to remember is that factoring companies aren’t looking for your money; they are looking for your customers’ money. The factoring company wants you to get paid so it can get paid, too.