Balancing Your Accounting Resources with Receivables Factoring

Your enterprise needs access to multiple credit sources. This is especially the case given the most recession, q recession where customers still aren't buying enough and one where customers are still taking way too long to pay their invoices. Unfortunately, lower demand and longer receivable collection times are par for the course. They are an inevitable outcome of a damaged economy, one where the recovery is a slow and painful process. Today's companies must combine their existing credit with alternative credit sources, ones that are easy-to-use and ones that improve a company's cash position. One credit solution that is becoming increasingly popular is receivables factoring. Simply put, receivables factoring is an asset-based financing solution that allows companies to use their receivables in order to set up a working credit line with a financing company. It's a solution that helps improve cash flow for many small and medium sized enterprises, and it's one that your company should investigate.

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During recessions, credit becomes more difficult to secure as banks and financial institutions tighten credit limits and terms. This directly impacts your company as it makes credit less plentiful and more expensive to manage. Ultimately, it directly impacts your cash flow as your customers continually delay their invoice payments in an attempt to improve their own cash position. After all, every company is burdened by the same cash flow issues. Every company wants to maintain a positive cash position. As such, it's more than likely that your own company is delaying its own payments to vendors. However, it doesn't have to be this way.

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Why Is Financing Difficult To Secure?

‍One of the most frustrating aspects of financing a business in today's economy is that most banks and credit unions are offering extremely competitive interest rates, and yet, companies are still unable to benefit from these low borrowing costs. In fact, in many instances, interest rates are the lowest they've been in decades. The problem isn't that financing itself is expensive; the issue is that affordable financing isn't available for most enterprises. Banks have been reluctant to advance capital out of fear that they'll incur losses. So why is it so hard to secure financing with a bank in this economy? More importantly, why are banks so concerned about lending capital to small and medium sized enterprises?

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In order to answer these aforementioned questions, it's important to reflect upon the most recent global recession. Once the recession hit, banks immediately responded by limiting credit and pulling back on existing credit lines. In response, the Federal Reserve instituted a series of quantitative easing measures, ones meant to free up credit within capital markets. The strategy was simple: The Federal Reserve would purchase mortgage backed securities from banks, and the low interest rate paid to these banks would incentivize them to lend money to businesses. Ultimately, banks would increase lending in order to generate a higher rate of return. Unfortunately, it hasn't quite worked out the way it was intended.

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The Federal Reserve has instituted three consecutive rounds of quantitative easing. Despite its best efforts, a large number of banks are still reluctant to advance capital to small and medium sized enterprises. Their concern lies in the risks involved in advancing capital to companies they see as less stable than their larger customers. As such, they've made the criteria for approval nearly impossible to attain. So how difficult is it to get approved for credit through a bank?

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One of the essential requirements for credit with a bank is that a company must have a solid credit rating and history. In this case, small and medium sized enterprises must provide all three financial statements and these statements must show consistent growth or performance over a five year period. Unfortunately, this all but eliminates start-ups and aspiring business owners, ones who have a solid business plan, but ones who ultimately can't provide the history of performance deemed essential by today's banks. This is ultimately why a number of small and medium sized enterprises are turning to receivables factoring. So what makes this asset-based financing solution so interesting? More importantly, how can you use this alternative credit source to balance out your accounting resources?

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Receivables Factoring As An Asset-Based Financing Option

‍Again, one of the biggest issues with a slowdown in customer demand is how long it takes your company to collect on a given receivable. Now, most companies ignore these costs. They assume that the costs to finance a receivable are minor compared to the costs of financing inventory. However, nothing could be further from the truth. In fact, in a number of instances, a company's costs to finance its receivables are much higher than its costs to finance its inventory. This is especially the case when customers take anywhere from 60 to 120 days to close a receivable.

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Receivable factoring can help in these cases because it allows your company to use its receivables as a source of immediate credit. Instead of waiting up to 120 days for your customer to pay their invoice, you simply sell that invoice to a financing company, one that will set up a credit line based on the value of the unpaid invoice.

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The advance provided by the financing company is upwards of 90 percent of the receivable's value. However, unlike financing with a bank or credit union, the decision to advance your company money doesn't rest with your credit rating. It isn't based on your company providing a history of performance. It isn't based on your company struggling to meet impossible criteria. Instead, the decision is based on how well your customer pays their invoices. In this case, it's the account debtor that the financing company concerns itself with. Therefore, if your customer has demonstrated a history of paying their invoice, then your company will easily secure the 90 percent upfront advance you need to finance your enterprise.

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Once the financing company purchases your receivable, they'll assume the responsibility for collecting on the unpaid invoice. When your customer pays the financing company in full, the financing company will reimburse your enterprise the difference between the 90 percent advance and the final customer payment. Finally, there is an administration fee and an effective rate charged for the financing services.

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Establishing a Credit Line Through Receivables Factoring

‍So what does it take to establish a credit line with receivables factoring? Well, the first thing your company needs to do is decide which customers it wants to use factoring with. In this case, you are deciding which customers to keep in-house, and under your existing financing, versus which customers you want to use receivables factoring with. Next, you need to provide all the information about the account debtor to the financing company. Include the customer's name, their location, their business type, their address, their phone number and any information concerning the amount of business your company does with this particular customer. The financing company will then review the credit history and rating of the account debtor. If your customer is accepted, the financing company will then establish the credit line.

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The moment you generate an invoice, you forward that invoice to the financing company. It's essential that you use factoring the moment the invoice is generated. If you wait too long, your company won't secure as high an upfront advance. Each time you generate an invoice, you send that invoice directly to the financing company. In return, the financing company advances your enterprise the capital you need to run your operations. In essence, you've used your receivables in order to set up a credit line, one where each new receivable is used in order to draw upon the capital you need to manage your business. By combining your existing financing with factoring, your company is able to better manage its accounting resources and improve its cash flow.

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Today's enterprises must combine multiple credit sources. While receivables factoring is a little more expensive than bank financing, its benefits allow companies to offset these costs by reducing their operating expenses. After all, there are benefits to having a strong cash position. Improved cash flow management means your company can lower its purchasing costs with vendors and creditors by prepaying or partially prepaying orders. Ultimately, receivables factoring is an asset-based financing option that can complement your current credit sources.