Stop Playing the Waiting Game

Tracy Eden

Many business owners anxiously wait by their mailbox each day to find out how they can conduct that day’s business. If much-anticipated checks arrive, that’s great—they can pay suppliers, meet payroll and tax obligations and perhaps take advantage of growth opportunities. If they don’t arrive, it may mean another sleepless night, wondering when all those checks that are “in the mail” will actually materialize.

This “cash flow crunch” is especially acute for fast-growth businesses in industries where customers tend to stretch payables out beyond 30 or 60 days. The fact is, more businesses fail due to a lack of cash flow than a lack of sales. Slow accounts receivable turns can literally bleed a business to death.

Offering open account terms to customers may be part of your cost of doing business, but have you ever thought about what it really costs you? If you’re waiting 30 days to be paid, you can only turn your profitability into more business 12 times a year. Imagine what a 90- or 120-day cash conversion cycle is doing to your cash flow and ability to grow!

Of course, another risk involved in open accounts is the risk that you won’t be paid at all. In their quest to grow, many business owners offer payment terms to customers with less-than-stellar credit. Even owners who try to be diligent when it comes to credit checks on new customers often don’t have the training or expertise to spot red flags that may indicate bad credit risks.

The Factoring Solution

One solution to both of these challenges is a long-established process that has received renewed attention of late as the bank credit crunch has taken hold: factoring. How do factoring services work? Commercial finance companies (known as “factors”) purchase outstanding receivables from businesses at a discount, usually between 2-5%. This way, the business receives payment as soon as 24 hours after generating the invoice, instead of 30, 60 or even 90 days later.

To better understand how a factoring service works, let’s compare it to what happens when you use a credit card to pay for a retail purchase:

Everyone who carries a consumer credit card has gone through an application process and been pre-approved for a particular spending limit, based on his or her credit and payment history, employment status, etc. With this card, an individual can acquire goods and services from a multitude of different product and service providers.

Let’s assume you are treating a client to lunch. You hand the waiter your credit card when he brings the bill and he promptly disappears behind a half-wall to “check your creditworthiness” by swiping the card through an electronic terminal. If the card is approved, you are allowed to “sign the invoice,” thereby paying for the service provided—your meal. Your next contact with this transaction is when your credit card billing statement arrives, which has recorded the transaction for your verification. You then submit payment to the “credit provider,” which in this case is the bank that issued the card.

But what’s happening on the restaurant end? At the end of each business day, the restaurant presents that day’s “pre-approved invoices” (i.e., credit card receipts) to the bank for payment—in effect, “selling them” at a discount. The restaurant does not receive 100 percent of the face value of the invoices, but a pre-determined percentage in exchange for being able to give customers the ability to use credit in their establishment. The restaurant will usually receive funds from its bank the next business day.

A factoring service does exactly the same thing as the bank in this example, but on a commercial basis. The factoring service purchases the account receivable from the company at a discount and is responsible for collecting it, just like the bank purchases a credit card transaction from a restaurant at a discount and is responsible for collecting payment from the customer. Payments from the business’ customer are mailed directly to the factoring service’s secure post office box, while payments from the restaurant customer are mailed to a bank post office lockbox.

Benefits Go Beyond Cash Flow

Remember that the benefits of factoring services extend well beyond faster accounts receivable turns and improved cash flow. For starters, the factoring service performs all customer credit checks to help spot bad credit risks, and sets appropriate credit limits for each customer based on these checks. Collecting accounts receivable, monitoring customers’ credit, and providing Internet-based account information are a few more of the valuable services factors provide. In essence, a factoring service can be a company’s full-time credit manager, accounts receivable clerk and collection agency all rolled into one.

Often, the accelerated cash flow that results from factoring is the catalyst that helps launch businesses to the next stage of growth or success. Factoring services can also be used by business owners who are planning their exit strategy as a vehicle to strengthen their balance sheet in preparation for selling the company or attracting new partners.


Tracy Eden is the National Marketing Director for Commercial Finance Group in Atlanta, GA
Judi Johnstone is Vice President, Business Development with First Vancouver Finance, Toronto, Ontario
Copyright 2009 Author retains ownership. All Rights Reserved.

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