Summary: Consulting companies are usually high-margin businesses but are expensive to operate. Professional services companies must retain highly skilled employees who command high salaries. Consequently, payroll is usually their biggest and most important expense.
Consulting companies must have enough working capital to cover payroll as the business grows. This is a challenge for new and growing consultancies and can lead to cash flow problems. This article explains how to improve a consulting company’s cash flow using factoring. We cover the following subjects:
- Payment terms and cash flow problems
- Reduce invoice payment time
- Finance your invoices
- Advantages of factoring
- Qualification criteria
- Stepping stone to other options
1. Payment terms and cash flow problems
Consulting companies typically work with commercial clients that require payment terms. While payment terms vary by contract, they typically give your clients 30 – 60 days to pay an invoice.
Established consulting companies have no problems offering payment terms. They have well-funded cash reserves. They can use their reserves to pay for expenses while waiting for payment.
It’s a different situation for startup or growing consulting companies. Their cash reserves may not be sufficient to cover expenses. This situation may lead to cash flow problems. Cash flow problems must be handled promptly. Otherwise, they can grow and worsen, leading to a downward spiral.
The following sections offer two strategies to handle cash flow problems. The first strategy reduces invoice collection time by changing your business processes. The second strategy involves using invoice factoring to finance your accounts receivable.
2. Reduce invoice payment time
Many consulting companies could solve their problems by making simple adjustments to their invoicing and collections process. These efforts can provide excellent results but will take some time to implement.
a) Improve invoice collections
Ineffective invoicing and collections are the source of many cash flow problems. The team is too busy and unable to spend enough time following up on payments. That is until you need the funds.
An effective invoicing and collections process can solve this. Its objective is to prevent problems from occurring in the first place. It should:
- Use well-written contracts
- Review business credit reports
- Offer payment terms selectively
- Get confirmation of client acceptance
- Invoice promptly
- Follow up regularly
This strategy will improve cash flow if your problems are due to invoicing issues. However, this will take time to produce results.
b) Offer early payment terms
Consulting companies that need funds quickly should consider offering early payment discounts. These are simple to implement and can work very well. Typically, the consulting company offers select clients a 2% discount if they pay within ten days. Otherwise, the client pays the full amount on their due date.
Many clients like these discounts because they increase their profits with no risk. The discount drops straight to their bottom line. On the other hand, consulting companies like them because they improve cash flow.
Early payment discounts depend on your customer’s willingness to pay early. Thus, they are optional. Your customers may stop paying early if they think a recession is coming or their situation changes. Consequently, they can be unreliable.
Consulting companies that need reliable cash flow should consider using financing. Typical solutions include lines of credit and invoice factoring.
3. Finance your invoices
An invoice factoring program finances your invoices for customers who pay slowly. It provides your consulting firm with funds to cover expenses and take on new clients. It works well for companies that need the funds to cover operational expenses, like payroll.
The solution can be deployed quickly. It is designed for small businesses and has easy qualification criteria. Read “What is factoring?” to learn more.
a) How does factoring work?
Most factoring companies finance your invoices in two installments. The first installment is deposited into your account shortly after you submit the invoice. This installment covers between 85% – 90% of the invoice.
The remaining 10% – 15% is held as a reserve to cover potential payment discrepancies. This amount, less the factoring cost, is deposited once your customer pays the invoice. This deposit settles the transaction.
A key difference between factoring and other types of financing is how transactions are structured. In most cases, the factoring company won’t lend you money. Instead, they will buy your accounts receivable and provide an immediate payment. This fundamental difference enables finance companies to offer this solution to small businesses. Read “How does factoring work?” to learn more.
4. Advantages
Factoring lines have advantages over other financing solutions. Used correctly, a factoring line provides a stable financial platform that can support growth.
a) Fixes cash flow problems quickly
The biggest advantage of a factoring program is that it can improve your cash flow, often quickly. This is why most consulting companies use factoring in the first place.
b) Grows with your business
The line is flexible and can grow with your consulting company. This is useful for consulting companies that have quick growth curves, such as those in marketing, management consulting, technology, and IT.
c) Quick deployment
Factoring lines can be deployed quickly, usually in a few days. It can be used by consulting companies with urgent cash needs for payroll or other expenses.
d) Available to small companies
Factoring lines have simpler qualification criteria than other solutions, like lines of credit or loans. This makes it an alternative for small and growing professional services companies that cannot obtain other types of financing.
5. Do you qualify?
The qualification requirements for most factoring plans are simple. Since factors buy your invoices, they usually focus their due diligence on these three areas.
a) Do your clients have good business credit?
The most important requirement to qualify for factoring is to have invoices from creditworthy clients. The invoices must be for delivered services and cannot cover future services.
b) Are your invoices encumbered?
Factoring companies need a first-position lien on the invoices they buy. Consequently, your invoices cannot be encumbered. Note that most conventional loans and lines of credit encumber accounts receivable. You will need a subordination from your lender in these cases.
c) Does your company have serious problems?
Your company must be incorporated and free of serious legal or tax issues. Companies with tax problems need to have a plan with the taxing authorities in place.
6. Stepping stone to other options
While factoring has several advantages, it is also more expensive than other solutions. In our experience, the line is best used to handle growth until you can transition to bank other options. These options may include ledgered lines of credit, conventional lines of credit, or loans.
Get more information
We are a leading factoring company and can provide high advances at low rates. For information, get an online quote or call (877) 300 3258.