Use Factoring to Boost Your Cash Flow

Many business owners anxiously wait by their mailboxes each day to find out how they can conduct that day’s business. If much-anticipated checks arrive, that’s great -- they can pay suppliers, meet payroll and tax obligations, and perhaps take advantage of growth opportunities. If not, they’re in a bind.

This cash flow crunch is especially acute for fast-growth businesses in industries where customers tend to stretch payables beyond 30 or 60 days. The fact is, more businesses fail due to a lack of cash flow than a lack of sales. Slow accounts-receivable turns can bleed a business to death.

Have you ever thought about what the real cost of offering open account terms to customers is? If you’re waiting 30 days to be paid, you can only turn your profitability into more business 12 times a year. Imagine what a 90- or 120-day cash-conversion cycle does to your cash flow and growth.

The Factoring Solution

One answer to this challenge is a long-established process that has received renewed attention of late: factoring. How do factoring services work? Commercial finance companies (known as “factors”) purchase outstanding receivables from businesses at a discount, usually between 2 percent and 5 percent. This way, the business collects payment as quickly as 24 hours after generating an invoice, instead of 30, 60, or even 90 days later.

To better understand how a factoring service works, let’s compare the process to what happens when you use a credit card to pay for a retail purchase.

Everyone who carries a consumer credit card has gone through an application process and has been preapproved for a particular spending limit. With this card, an individual can acquire goods and services from a multitude of different product and service providers.

Let’s say you’re treating a client to lunch. You hand the waiter your credit card when he brings the bill, and he promptly disappears behind a half-wall to “check your creditworthiness” by swiping the card through an electronic terminal. If the card is approved, you’re allowed to “sign the invoice,” thereby paying for the service provided -- your meal. Your next contact with this transaction is when your credit card bill arrives. You then submit payment to the “credit provider,” which in this case is the bank that issued the card.

But what’s happening on the restaurant end? At the close of each business day, the restaurant presents that day’s “preapproved invoices” (credit card receipts) to the bank for payment -- in effect, “selling them” at a discount. The restaurant doesn’t receive 100 percent of the face value of the invoices, but a predetermined percentage in exchange for giving customers the ability to use credit in their establishment. The restaurant will usually receive funds from its bank the next business day.

A factoring service does exactly the same thing as the bank in this example but on a commercial basis. It purchases the account receivable from the company at a discount and is responsible for collecting it. Payments from the business’s customer are mailed directly to the factoring service’s secure post office box, while payments from the restaurant customer are mailed to a bank post office lockbox.

Benefits Go Beyond Cash Flow

Remember that the benefits of factoring services extend well beyond faster accounts-receivable turns and improved cash flow. For starters, the factoring service performs all customer credit checks to help spot bad credit risks and sets credit limits for each customer based on these checks. Collecting accounts receivable, monitoring customers’ credit and providing Internet-based account information are a few more of the valuable services factors provide. In essence, a factoring service can be your company’s full-time credit manager, accounts receivable clerk, and collection agency all rolled into one.

Often the accelerated cash flow that results from factoring is the catalyst that helps launch businesses to the next stage of growth or success. Factoring services are also a good fit for business owners who need to strengthen their balance sheet in preparation for selling the company or attracting new partners.

Tracy Eden is the national marketing director for Commercial Finance Group in Atlanta.

Judi Johnstone is a vice president of business development with First Vancouver Finance in Toronto, a subsidiary of CFG.