If you run a company that bills clients, you must wait to receive your payments. While this is an excellent customer service benefit, it can present challenges for your cash flow management. You must pay for your daily operational expenses regardless of when outstanding invoices are due. Using accounts receivable financing can help you maintain consistent working capital.
What Is Factoring?
This funding type involves selling your invoices to a lender. The financial institution buys your accounts receivable minus a commission, then collects payments directly from your clients. This process ensures you have cash on hand to meet your necessary expenses.
What Are the Benefits?
This specific type of funding can offer flexible terms and has many additional advantages, such as:
- Offers fast access: You can receive cash quickly without waiting for customers to pay their bills.
- Decreases handling time: The company that buys your invoices will send payment reminders, collect amounts due and manage late payments.
- Minimizes debt: Because you are selling your assets, you do not need collateral to back the funding, and you do not incur debt as you would with a traditional loan.
- Optimizes working capital: You can help your cash flow by gaining immediate access to your revenue.
- Adds customer perks: You can extend longer payment terms to your clients.
What Are the Drawbacks?
Before deciding if factoring is right for your business, you must explore the potential disadvantages, including:
- Reduces profits: Companies that purchase invoices charge fees and commissions for their services.
- Maintains contingent liability: You are liable if clients fail to pay their debts to the finance company.
- Inhibits customer connections: Clients may feel discouraged by the lack of personal service regarding bills and payments.
- Incurs finance charges: Factors deduct a percentage of your accounts receivable for set periods. These fees can add up significantly over time.
Why Is Managing Cash Flow Important?
Even profitable ventures can go under due to mismanaged cash flow. Handling your revenue and expenditures can make or break your company. Your cash flow is your income minus your expenses, and you must ensure you always have enough to pay your suppliers, vendors, rent and other bills.
Factoring offers a finance alternative when your company is low on cash. It can provide a way to maintain your working capital during periods of meager income. However, it can be an expensive funding method with potential disadvantages. Considering the pros and the cons helps determine if this financing is right for you.