Do You Have The Ability To Offer Net-30 Without Creating Cash Flow Problems?
Accounts receivable cause a lot of cash flow problems for businesses
. This is particularly true when doing business with big business or the government. Large companies and the government are considered good credit risks but use their clout to stretch the net-30 day invoice cycle into 45, 60 and even 90 days. It causes the smaller businesses to struggle with having enough operational cash to continue filling orders and increasing their volume of business.It is especially true of small companies that are in the process of growth. While it is encouraging to experience growth, it can also be challenging to finance new orders, higher volume and aging accounts receivable. While accounts receivable show favorably on an accrual basis, accounts payable, payroll, rent, and other overhead costs weigh heavily on the cash flow situation.
In some of the metropolitan areas, some of the larger companies having plenty of cash diversify by offering to finance smaller companies that don't have the cash to finance their own accounts. Tire store customers are extended the 90 days same as cash by the furniture store. The furniture store buys the account from the tire store for factoring. More than likely, the furniture business is factoring accounts for the tire business. The tire business does enough volume and has enough markup to pay the discount and still make a healthy profit.
Another form of factoring is when a business accepts credit cards from consumers and businesses. A discount fee is charged to the merchant by the credit card Company for buying those invoices. The Credit Card Company pays almost immediately after accepting the credit card for a purchase.
Most factoring companies factor only business to business or business to government transactions rather than consumer credit. One difference between accepting credit cards and factoring invoices is that a Credit Card Company only makes one installment but a factor holds out a reserve until the factored invoice has been paid. Then the reserve minus a discount fee is paid. So Credit Card Companies pay in one installment whereas a factor pays in two installments.
An example of factoring is as follows:
1. Invoice for $10,000
2. Factor advances $8,000 almost immediately after being submitted.
3. The invoice is paid in full by the business client.
4. The business benefiting from factoring is paid $2,000 minus the discount fee of $400.
A business should have a goal of qualifying for a conventional bank loan. Thus, factoring is time-sensitive and transitional. Some Fortune-500 companies have actually found it was viable to grow the company by factoring invoices and purchase orders. Factoring of purchase orders is mainly for companies that offer products rather than services.
Factoring is a debt-free line of credit. And as the company grows, the amount factored increases automatically. It is actually not a loan but the sale of an asset. It is not listed on the balance sheet as a loan.
When the company gets into a position of being able to borrow conventional money, the bank is going to be very interested in how much the company is carrying in accounts receivable. When the business can show a profit without showing too much in accounts receivable, the bank is going to be more interested in making a conventional loan.
When a company has a net-30 days credit terms, in essence, it is as though the company is making a loan to a client. A factor is going to be more interested in your client's credit rating and ability to pay since the client is the one who will be paying for the factored invoice. So even though a company has some credit problems, if the clients are good for their money, the factor is going to be more interested in factoring those invoices.
Some businesses are capable of financing some but not all of their accounts. A factoring company does not always require that all of a company's invoices be factored. Furthermore, the company does not have to submit for payment immediately after the invoice has been issued. For example, if a company has the ability to carry accounts for 30 days and only needs factoring for the accounts extending past the 30 days, that is also possible. There is a lot of flexibility in factoring.
The bottom line is important but a business should always take into consideration the cash flow situation. When the cash flow is favorable, the company grows.
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