Businesses, from time to time, find themselves short of working capital. And, it is this limitation that is stopping some businesses from growing and forcing other businesses to shut their doors.
But, it does not have to be that way. While traditional business loans still remain hard to come by, there are other financing options, like accounts receivable factoring, that can help your business grow and improve; all without the hassle of talking to your bank or tapping your personal savings.
To obtain this form of business financing, you must first understand your business’s operating cycle.
All businesses have some sort of an operating cycle. This is essentially the time it takes a business to purchase needed materials or supplies and convert those raw materials into a finished product that can be sold.
Obviously, for manufacturing companies, the cycle starts with the purchase of raw materials. Those raw goods are then converted into a finished product and shipped to the end customer.
For retail businesses (including online businesses) the cycle starts with purchasing products for resale (inventory) then displaying those products on shelves or on a web site for customers to find and purchase.
For service businesses, while their operating cycle can be much shorter, they still see a time lag between providing the service (to include any purchases of material or labor to complete the job) and collecting payments from customers.
If the customer pays immediately, that cycle ends and profits are used to purchase new materials or supplies to start the next cycle. Thus, no strain on working capital and no outside financing is required.
However, not all customers pay immediately when products are delivered or services are rendered. A common practice in many industries is to prolong the operating cycle by allow customers extended periods to pay – even after goods are shipped or delivered.
This is called trade credit – allowing customers 10, 30, 60 or more days to pay after they receive the goods or services.
Think about your local hardware store that sells a bundle of lumber to a contractor but allows that contractor 60 days to pay – allowing the contractor to complete his jobs before payment is due.
Or, a corporate cleaning company that provides labor and materials to clean a business’s office space throughout the month but does not collect payment for those services until the end of the following month.
Or, a manufacturer that gives it customers 90 days or more to pay as is common in its industry.
While this might be a common practice, it does create some uncommon problems for many growing small businesses.
The problem that arises for most of these businesses is not having the cash on hand to cover other variable costs related to the operating cycle like paying labor. Or, not having the working capital on hand to start and complete that next job or to order more lumber for the next contractor.
How Accounts Receivable Financing Can Improve Your Business
In a perfect world, all businesses would have the necessary financial wherewithal to cover all their expenses while waiting for payment. But, this is not a perfect world.
Let’s say your business is facing a short fall in working capital. You have just shipped finished goods to your customer who will not return payment to you for the next 30 days. However, you have two other large customers that want your products now but you don’t have the cash on hand to purchase the materials needed to complete or even start those jobs.
However, when you shipped your goods, your business also invoiced the customer for those products. This invoice creates a binding agreement where the customer is obligated to pay for those goods by the due date.
If the customer does pay by that date (and they should or you should not be doing business with them), then you have an almost certain future cash event.
Given this future cash event, your business can factor that invoice for needed working capital today – capital to cover your employee’s wages, pay your own suppliers or vendors or even to start work on the next customer’s job.
In this situation, the accounts receivable factor (the financing company) will purchase your invoice for up to 80% of the future payment amount. The remaining 20% is used as a cushion should your customer either slow pay or not accept a portion of the goods shipped.
Then, when your customer does pay – the factor receives the full payment, retains the 80% they advanced and remits the remaining payment to your business less their fees.
In the end, your business receives enough working capital to immediately begin the next jobs and satisfy those very important customers.
While accounts receivable financing (invoice factoring) can be more expensive than traditional business loans or lines of credit, some business just do not qualify for a bank loan. So, they don’t really have much of a choice.
Therefore, many businesses that use accounts receivable financing will include these costs into their prices in hopes of covering the added expense.
But, do know this; it is far better to pay a little bit more for financing then it is to miss out on future opportunities (sales) due to a lack of working capital.
Thus, if your business is struggling to grow or finding itself unable to meet all its customers needs, don’t just accept it as a fact of business. Look for ways to improve that situation. And, accounts receivable financing might just be one of those ways.
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