Business Credit
3 business scenarios that need money to make money
Now that the economy is adapting to what is largely considered to be a new normal, many business owners are still adapting to new restrictions. Now with the second wave of coronavirus threatening to stall the recovery, it's anyone's guess when conditions will return to pre-COVID levels.
When times are tough, however, that doesn't mean cash flow can wait. Trust between business owners, their employees, and suppliers is more important than ever. Business owners are under pressure to maintain their payrolls and keep the inventory flowing. Not to mention the investments they have had to make to meet social distancing requirements.
Fortunately, there is no shortage of financing options available to small and large business owners. Chances are there's an option for you no matter where you fall across the credit-risk spectrum. One option for businesses is invoice factoring, and there is a way to use it effectively during the pandemic.
Before you can effectively use invoice factoring, it helps to understand what it is. Invoice factoring is a type of financing that's not a loan. In fact, it's not even the business owner's credit profile that is most important to invoice factoring companies. As a business owner, you sell your unpaid invoices - at a discount - to a factoring company. The factoring company cares more about your customer's ability to pay the invoice back. If you are currently working on your credit score and might not qualify for some other financing options at the moment, invoice factoring could be a good strategy to use during the pandemic and can help build your credit too.
In exchange for the invoice, you receive two payment installments from the factoring company. The first will be approximately 80-85% of the amount of the invoice(s) and the second will be for the remaining balance from the cash advance, minus any fees. It gives you quick access to working capital that you can direct towards urgent short-term needs. The customer will then pay the invoice to the factoring company anywhere between 30-90 days. The longer it takes them to pay the invoice, the more it will cost you.
No matter how badly you would like to see your invoices paid early, you will thank yourself later if you shop around first. Not all factoring companies offer the same features. For instance, let's take recourse vs. non-recourse factoring. This feature comes into play in the circumstance in which your customer fails to pay the invoice as agreed.
Recourse factoring - which is the most common type - places the responsibility on the business owner if the customer fails to pay the invoice. In this case, you are responsible for footing the bill to the factoring company. With non-recourse factoring, the lines are more blurred. It places the bulk of the risk on the factoring entity. Given that the factoring company is inheriting most of the risk, however, the fee is likely to be higher. This means that ultimately you'll see less of your sales if the invoice is paid.
Factoring fees can range from 0.5% to 4% per month. Non-recourse financing could cost you as much as 1% more than recourse factoring. When you are operating during uncertain times, you'll probably want to hold onto as much of your sales as possible. This is something to think about before signing on the dotted line.
Also, given that not all factoring companies are the same, spend some time talking to the factoring management team to learn about their debt collection techniques. The last thing you need during COVID is for unpaid invoices to wind up on your table. So learn about how persistent they are should push come to shove so you know that there is someone in your corner.
During the pandemic, you might be feeling more desperate for cash flow than usual. While it is understandable, it is also something you'll want to keep in check. Otherwise, you could find yourself sacrificing more revenue than you otherwise would just to meet an urgent cash need. While this might help you out in the short term, as invoice factoring could be delivered in as quickly as 24 hours, it could come at the expense of the long-term viability. Invoice factoring may not work in favor of your business if you sign too much of your sales away.
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