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Myths and Realities Regarding Invoice Factoring

Stephen Perl - 1st PMF Bancorp - Invoice Factoring

Stephen Perl – 1st PMF Bancorp – Invoice Factoring

In the first three posts of this series, I covered what you need to know about small business financing, how to align your funding sources with your funding needs and alternative sources for working capital. One of the important alternatives by which you can increase your working capital is through accounts receivable factoring. In this post, I will focus on some myths and realities surrounding invoice factoring.

What Is Factoring?

Accounts receivable (A/R) factoring, also known as “accounts receivable discounting” involves “selling” the A/R to a third party known as a “factor.” Factoring is customer and invoice specific. The factor may or may not be willing to fund (“buy”) all of your A/R invoices. There is a cost to factoring, which is typically 2 to 4 percent of the invoice’s face value. The purpose of factoring is to accelerate cash receipts due from sales made on credit.

Full-service factoring involves selling all outstanding receivables on an ongoing basis to a commercial finance company (factor). The factor pays for each invoice, withholding 2 to 4 percent as its fee, and manages the receivable until it’s paid. Under spot factoring, you would sell a specific invoice to the factor without any commitment to selling any additional invoices. Spot factoring is more expensive than full-service factoring, typically 5 to 8 percent of the receivable. Receivables may be sold with or without recourse. With recourse, if the customer defaults, you would have to attempt collection yourself. Without recourse, the factor would assume full collection responsibility. Factoring without recourse is more expensive because it carries a greater risk.

Myths and Realities

Even though factoring has literally been a source of small business financing for centuries, it’s still a frequently misunderstood option. Unfortunately, these misunderstandings, or myths, may prevent companies from utilizing what could be a very valuable resource for them. Here are some of the most common invoice factoring myths:

  1. Factoring Is Bad for Your Reputation
    The concern is that your customers may see your use of factoring as a sign that you’re in financial trouble. While factoring is a viable tool for startup companies, or those who are otherwise un-creditworthy, it’s also a very important tool for successful companies that want to rapidly accelerate their growth and need access to the working capital tied up in the receivables.
  2. Factoring Is Too Expensive
    While factoring is certainly more expensive than a traditional bank loan, it may be the only viable option for a business that doesn’t qualify for a bank loan to secure the funding needed to support their growth. Additionally, under full-service factoring, the factor may provide valuable additional services such as credit checks on potential customers, invoice account flow tracking and engagement in collections or related services as needed. A second important consideration is the time value of money. Can you earn more by having immediate access to the funds than the cost represented by selling the receivables? If factoring frees up the working capital necessary to support your growth, for example, and the profitability of the additional business available is greater than the cost of the factoring, then it represents a smart choice from a ROI perspective.
  3. Factoring Is Only for Small Companies/Factoring Is Only for Large Companies
    Factoring has nothing to do with the size of the company that desires to accelerate payment on their A/Rs. Certainly for small companies, especially startups without a credit track record, factoring may be the primary tool available to them to build working capital. Further, support from a full-service factor may actually represent an effective way to outsource the A/R management function. Many larger, established and profitable companies use factoring as a routine component of their cash flow management strategy.
  4. Factoring May Upset Your Customers
    Some customers may prefer dealing directly with you rather than with a third-party factor. This may be for the good reason that they appreciate the collaboration between companies. It may also be for the not-so-great reason that they feel it may be easier to delay payments if they’re dealing directly with you rather than with a commercial finance company that may be more assertive in collection activities and in reporting delinquent accounts to credit monitoring agencies.
  5. Factors Have Inflexible Rules and Are Difficult to Deal With
    Factors come in all types and sizes, and represent a wide range of business. For this reason, it’s important to investigate different factoring agencies to find an organization that suits your purposes at a price that you feel is a fair value for the services provided.

As with all aspects of business management, factoring represents a tool that may be right for you. Don’t be misled by invoice factoring myths. Understand your goals, investigate your alternatives and look for a strong business relationship.

In my next article in this series, I’ll take a look at public sector funding resources: what you need to know and how to proceed.

All I Want for Christmas is Cash Flow

All I Want for Christmas is Cash Flow

All I Want for Christmas is Cash Flow

As our children create their Christmas lists of toys they want the most, business owners are creating lists of their own. While they may also include some toys, perhaps Google Glass or the Apple Watch, a healthy and successful business is #1 on the list for most.

One of the best ways of measuring business health is cash flow. Healthy cash flow doesn’t necessarily mean making a lot of sales – although that helps. What you should be seeing when you look at your cash flow is more cash flowing in versus flowing out. This signifies healthy cash flow and solid working capital.

For many business owners, the holidays represent increased demand on working capital. Customers are buying more online and in stores as part of the holiday gift-giving tradition. This often means buying on credit versus paying with cash. While increased accounts receivable look good on the balance sheet, it does not equate to cash in hand. Instead, you are paying more for production, labor, inventory and related operational costs, while waiting to get paid. Hence, more cash is flowing out than coming in.

Fortunately, there are multiple ways a business owner can alleviate much of the stress that comes with this seasonal imbalance in cash flow.

  1. Have a Plan | The most efficient way is to have a plan. Spending decisions should always be made with caution in business. By planning strategically ahead of time for periods where you expect cash flow demands to be heavier, you can be better prepared to handle it financially.
  2. Negotiate with Suppliers | Negotiating supplier credit is another way to reduce cash flow demands. Making purchases on credit allows you to continue to meet customer demand, but with a lower immediate cost, freeing up cash flow.
  3. Leverage Accounts Receivables | Work with a factoring company such as PMF Bancorp. Instead of waiting for accounts receivable to be paid off, invoice factoring allows you to gain immediate access to that cash flow. Not only does this increase your working capital, but it also reduces the risk of unpaid invoices.

The holidays are time to celebrate, not worry about your business’s health. By planning ahead and having the right strategies in hand you can make it through the end of the year on a positive note and start the New Year off right.

7 Ways to Better Manage Your Cash Flow when Selling to Larger Customers….

Manager-In-Warehouse-Checking-BoxesThere are many ways to improve your cash flow, but how and who you sell may be the most important way you can control your cash flow. We all know and love those clients that pay COD, but they are far and few between. The reality is that larger customers in the US almost always take commercial terms (i.e. 30 to 90 payment terms). When selling to larger customers, many feel they are forced to take anything they are offered, but there are ways to get paid faster and better control your cash flow….

  1. Negotiate Vendor Agreement(s) – Even if your large customer says their terms are 60 days without exception, there still can be items that they can do to assist your company with its cash flow. They can often add a clause for early payments such as a 2% discount for a payment within a 10 day term…however, bringing your own independent financing through a factoring company can often save you a lot of money and provide more flexibility.
  2. Negotiate Terms of Delivery with Larger Customers – Better logistics equal better cash flow. For example, if you can have the larger customer pickup FOB China, then your billing can start sooner and a 60 day term can feel more like 30 days because you are not carrying the product as inventory. Often, using larger customers’ logistics can also save you money and time.
  3. Better Logistics Equates to Better Financing – When a business has better financing, it has better cash flow by default (in most cases). Logistics that is fast and without long holding periods for inventory is easier to finance. If you think of your inventory as a “Hot Potato” and hold it as little as possible, you will find better financing, profitability, and cash flow.
  4. Make Deals with Suppliers – Chinese Suppliers are tough, but if you take the time to visit and build a relationship with your factory, they will most likely support your company with some terms after the first year if your business has been smooth. Suppliers can be a great source of extra credit and relive strains on your cash flow, especially when selling to larger customers.
  5. Selling Smart – When selling to a large customer, we all dream of the big orders. These orders can just as easily become a dream as a nightmare. Start by selling small amounts by selling regions of retailers or via their online presence before rolling your product to all their stores. Even though buyers are looking for margin and product wins…you need to be able to win too. Sell smart.
  6. Visit Your Buyers – Good communications with you buyer(s) is essential and meeting up with your buyers for face to face meetings at least twice a year is even more important. This way you can establish a real connection and credibility that you are really working with them as a partner. They will, at least, feel motivated to give you a chance to compete if they are thinking of going with another vendor. Remember, without a real relationship, you are like the morning trash…ready to be taken out at any time.
  7. Get the Right Financing – Yes, we all think we should have a big credit line with the major bank across the street for at a half point over prime. Again, the faster you realize what financing is meant for your company, then the faster you can move on to selling and growing sales. Many small to medium size businesses need working capital to buy more products and to hire for staff…one does not need to beg a bank for a line to grow. Commercial lending banks that specialize in lending to businesses like PMF Bancorp can setup lines of credit, AR financing, trade financing and many other types of financing without the brain damage that the major banks cause. How? By looking at your good customer base and basing the line on the future sales growth and product, not past profits and tax returns which give little indication of future performance in many cases.