It’s no secret that the financial industry has been subjected to dramatic, sometimes disastrous changes over the past couple of years. Major banks and brokers have disappeared or been forced into disadvantageous mergers, while others are being resuscitated by infusions of government money. The survivors are somewhat shellshocked and understandably less inclined to lend, especially to new and growing companies.
Ironically, these are the companies that are busy right now planting the seeds of our economic future. They’re pioneers creating products that will ensure our prosperity. Most new jobs come from these innovative companies, so it’s in everyone’s best interest that they survive and thrive.
But where are they going to find reliable sources of capital? One potential source is a financing technique that’s been around for thousands of years: factoring. This is the process of selling accounts receivable at a discount in order to accelerate cash flow, and it’s been popular since the days of the Roman Empire. When Roman merchants extended credit to their customers, factors would advance funds to them against the future payments that were to be received. The same method was used to finance trade flows between England and its colonies in North America.
Sources Of Financing
There are three ways to finance a business: acquisition of debt, sale of equity/venture capital, and do-it-yourself financing.
Debt is still available to some companies. But you can expect future business loan covenant restrictions to be tightened as banks continue to harvest losses from years of inadequate requirements. Banks are going to require more capital and less leverage on balance sheets in the future to offset the risk of business loans.
Venture capital is also still available to some companies, although VC firms are becoming much more particular about the businesses they invest in. One of the biggest drawbacks to selling equity, however, is the dilution of ownership, a percentage of which is transferred to the investor in exchange for capital.
Factoring, meanwhile, is a form of do-it-yourself financing. Advocates of venture capital in particular will find factoring rates competitive. More important, factoring leaves ownership shares and control of the company in the hands of the original owners.
Factoring services tend to work best for companies that are able to generate consistent sales of products or services at the level of quality expected by a viable commercial customer. These sales should be completed and reasonably expected to be paid according to the terms of sale. The cash advanced by a factoring service can then be used to pay current obligations that support the company’s growth, like payroll, vendors, and other kinds of debt serviced by working capital.
While the costs of factoring services are higher than traditional small business bank loans, they’re mitigated by the additional services factors provide. A factor performs all the services of a full-fledged accounts receivable and credit department, including such tasks as backing up documents for accuracy and scanning, as well as folding, stuffing, mailing, and documenting invoices and payments in a ledgering system.
Vendor Trade Support
Little consideration has been given lately to the importance of vendor trade support, but the credit given by vendors is crucial to any successful entrepreneur. Success in business is often built on the support of those that sell to entrepreneurs and offer them trade credit.
Trade credit comes without interest, can expand rapidly, and provides a business owner with another way to leverage financing if treated appropriately. The liquidity provided by factoring accounts receivable enables a business owner to create vendor loyalty that is repaid in kind by increased trade credit lines. Often, by negotiating prompt or early payments, discounts can be realized that can improve profitability and help offset the costs of factoring services.
Wise entrepreneurs will retain and reinvest the profits from their increased sales. Establishing positive trends with respect to vendor relationships, improved liquidity, and growing sales will increase the likelihood that a business owner will be able to attain the next level of financing on more attractive terms.
In today’s difficult and uncertain credit environment, factoring services remain an effective way for companies to leverage their current sales and accelerate cash flow. Newly established and fast-growing companies especially should think of factoring as a potential first resource to meet their financing needs.
David Nordella is a vice president and business development officer with Commercial Finance Group, which has offices throughout the United States. Since 1974, CFG has provided creative financial solutions to small and medium-size businesses that may not qualify for traditional financing. You can learn more by sending an e-mail to firstname.lastname@example.org.