Does your company operate in a market known for long sales cycles? Do you often find it difficult to finance operations when so much of your cash is spent financing receivables? More importantly, have you simply grown tired of trying to finance your long-term growth with conventional financing, and simply want another, low-cost solution? Well, if you’re looking for either an alternative financing solution, or a supplementary financing option, then look no further than receivables factoring. Companies in all kinds of industries have come to rely upon receivables factoring as a means to improve their cash flow, reduce their costs of financing and protect their profit on sales. In fact, factoring is but one of several asset-based financing solutions that empower companies to reduce their long-term financing costs.
One increasingly popular strategy for today’s companies is to combine conventional financing with alternative financing. This often involves using bank loans and business credit lines with several asset-based financing solutions. The focus is to use a combination of these aforementioned strategies in order to reduce the company’s costs of financing, improve its cash flow and protect its profit on sales. Along the way, a company is able to finance its operations and secure its long-term future.
Companies that operate in industries with long sales cycles are ones that are able to benefit from fairly strong customer relationships. After all, once a customer finally does decide to move forward with a particular vendor, they don’t take that decision lightly. Instead, they base their decision on the vendor’s ability to meet their stringent criteria. In essence, the length of the sales cycle implies that customers take their time making decisions and because of this, they are less likely to switch at a moment’s notice. However, supporting industries with long sales cycles is extremely difficult because it takes so long to generate a return on sales.
Companies that operate in industries with long sales cycles are ones that struggle with financing on a daily basis. They simply lack the ability to consistently collect on open invoices. In addition, many companies in industries with long sales cycles are ones that have to support extended customer terms and larger credit limits. A perfect example would include the construction industry where companies must have a large financial outlay of cash to support operations and projects, but who lack the consistent and immediate receivables collections to improve cash flow.
To help alleviate the going concerns of an uneven cash position, companies that operate in long sales cycle industries have the ability to benefit from several options with respect to asset-based financing. For instance, when a company totals all of its assets under its possession, it typically looks at its real-estate holdings, the value of its inventory, its current backlog on sales, its existing long-term contracts, any equipment or machinery it owns and finally, its open receivables.
Each of these aforementioned assets can be used as a form of collateral. A company can borrow against the value of any real-estate under its possession. For instance, if the company owns its building or warehouse, it can then use it as a form of collateral. A company can borrow against the value of its inventory in order to establish a business credit line. In this case, it must have a high inventory turnover rate and not have any issues with inventory obsolescence and theft. This is because a fast moving inventory is needed in order to cover the credit line. A company can also use purchase order financing in order to secure the capital it needs to fund the purchase of raw materials, consumables and products to complete customer orders. Finally, the amount the company’s customers owe on outstanding invoices is an important asset and one that can be used to finance the company’s operations. It’s this last option that forms the basis of receivables factoring.
Receivables factoring allows companies to establish a working credit line based on the value of their customers’ outstanding invoices. However, earlier invoices will secure a higher capital advance for the company, so it is essential that companies use factoring immediately upon generating a customer invoice. The financing enterprise will advance the company a percentage of the receivable’s value. In return, the company essentially sells the invoice to the financing company who then proceeds to collect directly on the invoice. Once the customer pays their invoice, the company is reimbursed the difference on the original advance and the final payment. The financing company then charges the company an administration fee on the receivable’s total value, and an effective rate against the advance. That effective rate is made up of an interest rate and the current prime rate.
• Is Receivables Factoring New? Perhaps the biggest misconception concerning receivables factoring is that a number of enterprises see it as a new form of financing. However, this simply isn’t the case. Factoring has been a financing solution for thousands of years. It has helped everything from the textile and garment industry to the construction industry, while also helping retailers and wholesalers. It is a proven asset-based financing option, one where millions of enterprises worldwide use it to balance out their cash flow.
• Are There Different Options With Respect to Factoring? There are essentially two options with respect to receivables factoring: Recourse factoring implies that your company assumes some liability for your customer’s final payment. Non-recourse factoring implies that your company assumes less risk, or in some cases, no risk on the customer’s final payment. However, it’s important to understand that non-recourse factoring isn’t as readily available as it once was. This is because the financing company typically has to purchase credit insurance, or credit default insurance, in order to protect itself against the possibility of bankruptcy on the part of the account debtor, which is the customer owing on the invoice. As such, non-recourse factoring is less likely to be made available to today’s companies as it adds costs and implies more risk for the finance company.
• What is the Amount of the Advance and how is it Applied? Your company can secure an advance of anywhere from 80 to 90 percent of the receivable’s value. However, this depends upon the type of financing entity your enterprise chooses to work with and the types of options they provide. For instance, if that financing company offers a non-recourse option, then your advance is likely to be 80 percent of the receivable’s and you are likely to pay a higher administration fee and effective rate on the cash advance. If the company only offers recourse factoring, then your advance is likely to be higher and your administration fees and effective rate are likely to be lower.
• How Are the Fees Applied? Receivables factoring works by charging a small fee against the receivable’s total value. The effective fee rate combines an interest rate with the current prime rate along with administrative fees bundled together in a simple form. This is different from conventional bank financing whereby your company pays a daily interest rate for every day it finances its receivable. The longer it takes your customer to cover their invoice, the higher your costs to borrow money. Ultimately, delayed receivables collection impacts your cash flow and increases your costs of financing operations in either option.
• Does My Company’s Credit Rating Impact the Financing Company’s Decision to Lend? The financing company is mainly concerned with the account debtor’s ability to cover their receivable. If your customer has a history of covering their receivables, then you are more than likely to get approved on factoring. As such, the focus is on your customer’s ability to pay and not your company’s credit rating or history.
• Is Receivables a Loan? Factoring itself is not a loan and won’t be shown as one on your company’s balance statement. While it acts as a loan, it is more of a capital advance on the value of your outstanding receivable. This makes receivables factoring an immediate solution to handling the high costs of financing sales in a long sales cycle market.
Factoring is a proven solution for today’s enterprises. It helps companies pursue all opportunities, regardless of their size, the capital needed to finance operations and most importantly, the time needed to close sales. For companies that operate in high sale cycle industries, factoring represents a simple and effective solution to financing a company’s operations. It improves cash flow and reduces the company’s borrowing costs.