Most mature businesses have figured out the cash-flow game. Their accounts receivable cycle is refined enough that there is consistent cash coming in to fund projects, pay suppliers, and all while keeping the level of cash on hand adequate. New businesses or those that don’t yet have a handle on their accounts receivable cycle can struggle with cash flow. When cash falls to near zero and suppliers are ringing, panic can set in.
Fortunately, there’s a way to alleviate cash flow problems – it’s called invoice factoring. Invoice factoring advances the value of your outstanding invoices as cash. This fills the business’ coffers and allows the company to find its footing, getting it back on track, if only temporarily in some cases.
Who is the ideal candidate to use invoice factoring? There isn’t a single perfect scenario. But three different types of business scenarios are ideal candidates.
The Cash-Starved Startup
Startups have a lot on their plate and may not have the best management in place during initial hiring. This can lead to miscommunications and bad decisions. For example, a new company may decide that net 90-day terms will pull in more clients and help the company grow. But someone forgot to tell A/R that suppliers want to be paid within 30 days. Now there’s a 60-day gap to cover. This gap can quickly eat all available cash and put the company into scramble mode.
In such a reactionary state, the company will find it difficult to make any long-term decisions. It must put out the cash-shortage fire immediately. Meaning, find a way to generate cash flow. A traditional loan will take too long. The company has already maxed out its line of credit. To fill the hole in its bank account, the company decides to use invoice factoring.
In just a few days, the factor approves the company and immediately advances 85% of the value of its outstanding invoices. Because the startup is so focused on growth, it will eventually get its accounts receivable cycle under control. If the company were in decline, invoice factoring would not do much to save it.
A well-managed company may still need more cash than is on hand. A project that shows a high return but has a small window for completion must be seized upon fairly quickly. But, if the cash isn’t there to fund the opportunity, the company will miss out. A traditional loan will take too long to approve, and there isn’t enough line of credit available to make up for the shortfall in funding.
Invoice factoring can once again come to the rescue. Mainly because of its fast approval times and easier qualifications than a traditional loan, invoice factoring is a great option when cash is needed fast.
There is a cost for using invoice factoring. But if the project’s return far outweighs the cost, then invoice factoring should be used.
Finally, we come to a business that is neither a startup nor a thriving, mature business. Its growth is in decline, and top management has been jumping ship. Employee morale is low, and nothing the company has done so far has helped to turn things around.
To make matters worse, the company is behind on its payment to suppliers. Suppliers are now threatening to cut the company off unless they are paid. With little cash remaining and customers still on net 60-day invoice terms, the company doesn’t have a solution to solve the supplier problem.
The company has tried to get a traditional loan and an additional line of credit, but, with poor financials, it’s been turned down by creditors. Fortunately, it does have outstanding customer invoices. These customers are business-to-business, creditworthy, and the company generates enough in invoices each month that it will likely get approved for invoice factoring.
Invoice factoring can certainly solve the supplier payment problem for this company. But that is only a Band-Aid. The company has systemic issues that invoice factoring cannot solve. Management will need to come up with a new strategy because, eventually, there won’t be enough customer invoices to meet the factor’s requirements.
Invoice factoring is a versatile financing option that can meet the needs of many financial scenarios. It does have a higher cost than that of a traditional loan, but is also quicker to approve and has less stringent approval qualifications.
For a growing company, invoice factoring is another financing tool among different financing options. For a company in decline, invoice factoring may only slow the inevitable.
Keep in mind that the factor takes over the handling of payments with customers. Basically, your company must give up that part of the business. For some, allowing another company to take over payment collections is a plus. For others, it can be a negative as it breaks a consistent flow in their customer service. Each company will have to weigh these pluses and minuses and decide if invoice factoring is right for them.