Financing is the process by which funds can be raised from places of excess and put to good use. This ranges from getting working capital for business activities so you can start your own business or make the down payment on your new home. To put it simply, finance involves managing funds and the process of acquiring those funds in the first place.
In this article, however, we will be talking about a specific type of finance. Accounts Receivable Financing, also known as “Factoring” is a quick way for businesses to raise working capital for business activities.
WHAT ARE ACCOUNTS RECEIVABLE FINANCING?
Most companies work on invoices, as they do not demand money upfront for the product or service they provide. For example, you will pay your milkman at the end of the month for what he is owed. A business will also pay its suppliers after a set period rather than before-hand. However, the milkman will have his own bills to pay for and petrol to buy for his milk-mobile. For this, he will require liquid money. Similarly, an invoice will not pay a company to run its business and until the accounts receivables are received, no working capital is available.
This is where Accounts Receivable Financing comes in. Factoring companies will actually buy off your accounts receivables and keep a small cut. It is providing you with the working capital you need to run your business or even expand it. This would be like the milk-man getting paid by a third party at the start of the month, and you are paying the third party, like accounts receivable financing company at the end of the month. Solving the cash-flow issue and ensuring that the business keeps running.
This kind of financing, however, has its own drawbacks as well. It is entirely dependent upon the unique financial position and nature of a business whether factoring is the way to go.
Availability of Working Capital
If you use factoring, you will not have to worry about having cash tied up as invoices. Selling your customer’s debt to factoring companies provides you with liquid cash that can be used to improve your company. You will not have to wait for your customers to pay their bills before you can reinvest. The money can allow you to get started on hiring new staff, improving your equipment, maintenance, and buying new assets.
Best Choice if you are a new business
Start-ups and new businesses generally face difficulties getting loans and investment. Banks are wary of untested start-ups with their investments, and this can prove frustrating if you own the said start-up. Liquid cash is also of the utmost importance when starting a business and you cannot wait until next month for customers to pay their invoices. This becomes even more frustrating because asking for payment straight-up is not the best way to garner more customers.
In this situation, selling your accounts receivables to a factoring company is your safest bet at getting finance and growing your start-up. Factoring companies do not look at the business’s ability to repay but at your customer’s ability to pay their bills.
Generally speaking, getting most bank loans requires you to have collateral. This is basically borrowing against your assets. In the case of non-repayment of the said loan, the asset is seized by the loan-provider. This can be incredibly scary, especially if you are starting a new business that has a high risk attached to it. You do not want to lose your house over a failed business idea. This will also stop you from taking any real risks and from thinking creatively-both things you require to grow a new business.
Accounts Receivable financing does not require collateral. You will be able to run your business without having to worry about the consequences of failure too much. This cushion will allow you to make creative decisions and innovate and grow your business.
Full Control Retention
Most investors require a portion of ownership in return for providing you with the investment. This can take away your control over your own company. This also means that if you grow your business, you will not be fully reaping the rewards of your own hard work. A proportion of your profit will also go to the investors.
Factoring companies do not require equity, allowing you to retain full control over your business.
No need for a billing department
Billing schedules and billing cycles are difficult to manage. Most businesses have to maintain a separate billing department to keep track of their customer’s payments. This means hiring more people and paying their salaries and needing office space. All these add to your business’s running costs. Less money is available for research and development and other departments that help grow your company.
Delegating that work to Factor companies frees up time and resources for you to devote to growing your business.
No risk of bad debt
Most companies have to account for bad debt. This is when your customers can not make their payments. Bad debt can be very costly for your company and selling all debt allows you to sidestep that particular issue.
Factoring companies take their cut
There is no such thing as a free lunch. The same goes for factoring, unfortunately. Factoring companies tend to demand an upfront fee. They also tend to hold a little amount in reserve until your customers pay up.
The fees charged could be more expensive than other forms of debt
Depending on the contract you have with your factoring company, it could be more expensive than other forms of financing. The fees and other cuts could stack up to about 18% of the value of the accounts receivable if you are not careful.
Rate is based on clients
Your history does not matter when it comes to factoring, but your customers. This can be a bad thing too. Since the rate charged is dependent on your customers, it will not be under your control.
Accounts Receivable financing is a quick way of getting working capital fast. It is also a handy tool for start-ups and new businesses trying to grow. However, much like any other kind of financing, care must be taken in employing this to raise funds for your business. If used smartly, factoring can allow you to have your cake and eat it too! Happy Financing!