Why Factoring Isn’t the Solution to Improving Cash Flow
Unpaid invoices and late paying clients are two very real challenges that can put immense pressure on today’s small business owner.
In fact, according to a 2012 Wall Street Journal survey, 64% of small businesses have unpaid invoices of more than 60-days old. A problem further compounded by the fact that these businesses often have few cash reserves and less access to loans.
With limited access to financing options, many small businesses turn to invoice factoring, a service that turns accounts receivable (i.e. unpaid invoices) into cash in a matter of days, thinking it is their only option. But what is factoring and what are its implications for the future of the your business? Is it right for your business and if not, what are the alternatives for accessing capital fast?
Invoice Factoring – The Last Resort or a Valid Option?
Accounts receivable factoring puts cash in the hands of business owners quickly, allowing them to circumnavigate potentially crippling net 30, 60 or 90-day payment terms. The process is a fairly simple one. Once you enter into a factoring agreement, you invoice a client as usual, then submit the invoices that you wish to factor to an invoice factoring company (aka the “factor”). The factor then advances a percentage of the invoice sum to you. Once the end customer pays the invoice, the factor remits the balance, minus a transaction (or factoring) fee. It is important to note that factoring is a 3-way transaction, because the end customer pays the factor directly, and not the business.
Factoring is fairly simple and well-known, but it’s not without its cons. Factoring can be costly – with financing costs easily exceeding 15-20% of the costs of the receivables. For businesses who already pay out a significant chunk of change in taxes and other expenses, factoring might not be the best option for generating cash flow. Also, many business owners are concerned that bringing in a third party will hurt their relationship with their clients, or might wrongfully signal their clients that they’re in a poor financial position.
Financing Alternatives to Factoring
Contrary to what many business owners believe, if you have large amounts of cash tied up in your receivables, factoring is by no means the only way to give you back control over your cash flow. There are alternatives.
Cash flow management and optimization solutions such as Fundbox are a good example. These types of products offer a low-cost way for freelancers, service providers, and others to cash in on their invoices before receiving payment by advancing businesses the full amount of their outstanding invoices. Some can even be connected to your invoicing software, making the process lightning-fast and fully online.
Instead of skimming a hefty percentage chunk off the top of the invoice like factoring does (plus a service fee), customers pay back the amount, plus a per-invoice clearing fee, on weekly installments. Another difference from factoring is that these types of products only charge the business when the advance is outstanding. Fees are waived for the remaining period if the business pays the balance early, and your customers never know about the cash advance.
Other Ways to Optimize Cash Flow with your Invoices
Of course, a speedy injection of cash from third parties isn’t the only option to cash flow worries. Optimizing your invoice process is another way to ensure that customers are invoiced in a timely manner and payments are expedited. A few ways to do this include:
- Offer incentives for upfront payments or pre-paid contracts. Offer discounts for early-payments or encourage contract customers to pay half upfront and half on project completion.
- Invoicing early and more frequently. Don’t wait till the end of the month to bill clients, invoice as soon as work is completed or consider changing your billing cycle so that you’re billing clients more frequently.
- Check the details on your invoice. One often overlooked contributor to payment delays is an invoice that lacks the right details. For example, do you have a purchase order number listed? Are your payment terms and “Make Payable To” details accurate and clearly displayed? If you’re dealing with a large corporate client, include a copy of your statement of work or signed proposal to help expedite approvals.
- Use an online payment system. Encourage clients to set-up direct deposits so that you don’t have to wait for checks to clear or consider online payment services like PayPal, Selz (great for freelancers, bloggers and those selling digital products or services) and Google Wallet. For global payments, consider Payoneer or Stripe.
- Move to an online accounting system. Tools like Freshbooks, Quickbooks and Xero can introduce efficiency into the invoicing process. Instead of sifting through Excel or paper records, you can create, track, and manage invoices easily, automatically alert customers to overdue invoices, and integrate records with your accounting system. Here’s some more info about how and why to move to an online accounting system.
- Follow-up like you mean it. A polite email or call at the point that a payment is one-day past due is perfectly reasonable. Reach out to your business contact (the person who values your service) and have them do the internal chasing for you.
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