Factoring: What You Need To Know as a Small Business Owner
The whole accounts receivable process is pretty straightforward: provide a product or service and get paid. Unfortunately, as anyone who runs a business knows, things rarely go this smoothly. Outstanding balances remain for months, straining cash flow and hampering general business practices. For entrepreneurs who consistently run into this problem, factoring may present the most viable solution. To decide whether or not you should work with a factor, you need to understand the basics of this practice.
Selling Your Accounts
Once you’ve completed a service, you’re owed money. That gives the invoice for your work value, and factoring companies are willing to purchase those accounts and take over the collections process. Essentially, you sell your services to the customer, and then sell the customer’s bill to a factor. The cost to the business owner is usually a small percentage of the amount owed. For some companies, it might not make sense to give up a portion of accounts receivable; for others, the money lost is made up for in time saved and relief from cash flow issues. Selling invoices might enable you to conduct more business, in which case the amount paid to the financing company is probably worth it.
Pros and Cons
As stated, the most obvious pro is steadier cash flow. That means less time spent wondering if you’ll be able to pay rent and utilities, and it also might enable you to grow your business faster. Another benefit is putting an end to uncomfortable collections calls. When you have to hound customers for money, they become less eager to respond to your calls and emails. When you pass the invoice to someone else, you can keep money out of the conversation.
Of course, there are some drawbacks with factoring. If you work with people and businesses that don’t have stellar credit, you might have to pay a higher percentage. You also need to be sure the factor is trustworthy, as there’s no point in selling an invoice if you have to turn around and hound the financing company for payment. If you don’t have a high enough volume of invoices, this option might hurt your cash flow more than it helps. It’s important to do some research before committing to any sort of contract.
For the right small business owner, factoring can be the perfect way to keep money moving and customers happy. Before taking out a loan or throwing in the towel, talk to a financier and see if this option might work for you.