Does Factoring Protect Your Future Cash Flow?
Giving your customers terms (net 30, net 60, etc.) is a great way to boost your sales. But while you’re generously helping your customers with their cash flow, you still need to worry about your own books, paying your employees on time and ordering your own inventory.
We all know this story. One common way to free up some of your cash flow today is by factoring.
But what are you doing to protect your business from falling right back to where you are today?
The Traditional Fix – Factoring
Factoring is the act of selling your accounts receivable at a discount to a third party (the factor). They’ll typically pay you around 75% of the sale upfront. Once they collect from your customer, they’ll give you the remainder, minus the discount fee they take – between 3% and 6%.
Two Benefits of Factoring
1. Quick infusion of cash
Factoring brings in the cash that you need now, without having to wait to collect from your customers. It bypasses the normal sales cycle and brings you the money your business seriously needs.
2. Moves the risk to a 3rd party:
Factoring transfers the risks of accounts receivables to a another party. They handle the collections, allowing you to focus your energy on more important aspects of your business.
The Downsides of Factoring
1. It hurts your margins:
By selling your accounts receivables at a discount, you are cutting into your margins you make on each sale. In essence, you are short-selling the true value of each sale you make, which can over time hurt your business.
2. It’s expensive:
Business Week does a great job explaining how expensive factoring can become. The factor gives you around 75% of the account up front, and then pays you the remainder, minus a fee, once they collect from your customer. This means that a factor will get a fee of 2% to 5% of the first 30 days the invoice is outstanding, and then there will be a .125% to .06% fee for each additional day. As Business Week notes, factoring can get expensive very quickly
3. It’s one-sided:
Factoring doesn’t help any part of your business aside from your cash flow cycle. As a post-invoice solution, you can’t use it to help your customers in any way or grow your own sales.
4. It uses old fashioned risk analysis:
Factors use risk-analysis methods akin to those of traditional banks. This means they only see a narrow picture of who you are as a business, and therefore will have higher denial rates. And due to their smaller risk-appetite, factors prefer to work with larger companies that they feel carry lower risks, thus eliminating many smaller cash-hungry companies.
Proactively Protecting Your Cash Flow
To properly address your cash flow needs, you want to find a system that addresses your cash flow issues at their source. Factoring is designed to help businesses who are in a crunch. But if you can better manage your cash flow from the outset, then you can avoid the crunch altogether.
By putting a system in place pre-invoice, you’re proactively addressing your cash flow concerns – instead of waiting till you find yourself in a tight spot.
This is why we try to resolve the cash flow challenge a priori by paying vendors on behalf of their small business customers. So vendors don’t need to take on the risk of defaults that could lead to their need to factor, and the customers can manage their cash flow with more access to working capital.
Factoring definitely helps vendors out of a cash flow crunch. But proactively finding the solution to your cash flow issues – before they begin to drain your business – will help prevent the next crunch from happening.