Summary: Most small technology consulting firms have trouble getting financing when needed. Qualifying for a loan or line of credit is difficult. Few small companies can meet the qualification requirements for these solutions.
This article discusses how to finance your cash flow using invoice factoring. Factoring is an alternative form of financing that has gained traction as a solution for small and midsize consulting companies. We cover the following:
- Do you sell products, services, or both?
- Do you have cash flow issues?
- Improve cash flow with factoring
- Advantages of factoring
- Things to keep in mind
- Progress billing and pre-billing issues
- Do you qualify?
1. Do you sell products, services, or both?
Most technology consulting firms that come to us for financing fall into one of three business categories. They sell services, products, or a combination of both. These companies are often small and don’t have many of financing options.
The three categories of technology companies usually face similar financing challenges. Technology companies that provide services usually need funds to cover payroll. Companies that sell products, usually computing and networking equipment, need funds to pay their suppliers. Lastly, companies offering services and products need funds to pay employees and vendors. Each of these situations is handled differently.
2. Do you have cash flow issues?
The most common cash flow problem that small technology companies face occurs because they offer payment terms to their clients. Payment terms, often referred to as net-30 accounts, give their customers 30 to 60 days to pay their invoices.
Offering terms can create a problem for some companies. This is because small companies don’t always have the resources to deliver the services and wait up to 60 days for payment. Consequently, they risk getting into financial problems. This problem usually affects companies with limited cash reserves.
a) Do you sell products?
Companies that sell technology equipment usually have a different financing problem. They need funds to pay their product vendors.
Most small companies cannot get terms from their vendors. Instead, vendors demand an upfront payment or a payment upon delivery. This situation creates a cash gap for the small company. Vendors need to be prepaid but clients pay their invoices on 30 to 60-day terms.
This limits the technology consulting company’s ability to grow. They can only fulfill the transaction if they have enough funds to pay the vendor.
If your company faces this challenge, consider using purchase order financing. This article won’t go into detail about how to solve this specific challenge. However, you can learn more by reading “How does purchase order financing work?”
3. Improve cash flow by using factoring
The simplest way to improve your cash flow is to use invoice factoring. Factoring allows you to finance your net-30 to net-60 invoices from creditworthy commercial clients.
The consulting company no longer need to wait up to two months for payment. Instead, they get funds from the factoring company. This provides the cash flow you need to cover payroll, pay suppliers, and pay other business expenses.
Most factoring lines are not structured as loans. Instead, clients sell their invoices to the factoring company in exchange for immediate funds. Structuring the transaction is an asset sale rather than a loan ensures the solution is available to small businesses and can be deployed quickly.
b) How does factoring work?
Invoice purchases by factoring companies are financed in two installments. The factor deposits the first installment into your bank account as soon as the submitted invoice is approved. The first installment covers about 85% of the invoice’s total amount.
Factors retain 15% (varies) until your customer pays the invoice. Once the invoice is paid, the factoring company deposits the remaining 15%, less the factoring fees, into your bank account. This payment concludes the transaction. However, most companies use factoring regularly to improve their cash flow.
To learn more, read “How does invoice factoring work?”
Factoring has several advantages over business loans and other solutions. The most important advantages include the following:
a) Provides working capital quickly
Companies use factoring because it solves their cash flow problem by providing working capital quickly. It can be an ideal solution for companies that urgently need funding.
b) Offer net-30 terms easily
Factoring enables you to offer 30-day terms to clients while minimizing your risk of cash flow problems. You can always factor your invoices if you need funds.
c) Easy line increases
Your line can be increased easily since it is tied to your sales. The main requirement is that you provide good services and sell to creditworthy companies.
d) Easy qualification requirements
Factoring lines have simpler qualification requirements than other solutions. Consequently, they are a great alternative for startups and small companies.
5) Things to keep in mind
Factoring has three limitations that can affect some technology consulting companies. They are the following:
a) Only solves a specific cash flow problem
Factoring lines are designed to solve a specific problem. They will help if your cash flow problems are due to slow-paying invoices. However, factoring may not be helpful if your financial problems are due to other issues, such as low sales.
b) Comparatively expensive
Factoring lines are comparatively expensive relative to other solutions like lines of credit or business loans. Consequently, they work best if your clients pay in less than 60 days and your profit margins are over 20%. In our experience, most technology consulting companies that sell services usually have margins substantially higher than 20%.
c) Issues with pre-billing and progress payments
Factoring companies won’t finance pre-billed invoices. These invoices are sent to clients before delivering your products or service. Additionally, most factoring companies won’t be able to finance invoices for project stages. We cover both of these issues in the next section.
6) Pre-billing and progress billing issues
Some technology consulting companies pre-bill for their work and present an invoice to the customer before the service is provided. We usually see this issue when consulting companies charge for support services at the start of the month.
Unfortunately, these invoices cannot be factored until you have delivered the work to your customer. This is due to the risk associated with these invoices.
Technology companies often invoice for large projects in stages. Sending an invoice after each stage is completed is commonly called ‘progress billing.’ Most factoring companies are unable to finance progress billing invoices. However, progress invoices can be financed using specialized factoring companies.
Progress invoices can be problematic because payment could be jeopardized if something goes wrong at a later project stage. Additionally, they can be difficult to verify.
7) Do you qualify?
Factoring plans have a simple underwriting process. To qualify for factoring, your company must:
- Invoice on net-30 to net 60 terns
- Work with creditworthy customers
- Have invoices free of encumbrances
- Not have serious legal or tax issues
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.