Summary: Most companies have a cash shortage at one time or another. Cash shortages often happen to companies that add customers quickly and outgrow its cash reserve. Cash shortages can lead to further problems if not fixed correctly. This article provides practical strategies to prevent cash shortages. It also explains how to handle a cash shortage quickly by using invoice factoring. We cover the following:
- Prevent cash shortages
- Factoring improves cash flow quickly
- Advantages of factoring
- How quickly can you get funding?
- Do you qualify?
- Long-term strategy
1. Prevent cash shortages
It is easier to prevent a cash shortage than to fix one. However, implementing the techniques to avoid a cash shortage requires discipline and persistence.
a) Have a good collections system
Every company must handle its invoicing and collections correctly. Without a good collections system, clients won’t pay on time or at all. This is the first and most important step in preventing shortages.
b) Build a cash reserve
The simplest way to prepare your company for a cash flow shortage is to build a cash reserve. This essential step helps you through most financial problems.
The best reserve size is a matter of debate and preference. Ideally, the reserve should have enough money to run the company for a few months. This goal sounds difficult, but every company must have a reserve. It’s best to start building one early and slowly. Take small but deliberate steps.
c) Provide terms only to good clients
Commercial sales are usually made on payment terms. Clients typically want 30 to 60 days to pay an invoice. You should offer terms only if you can afford them and the customer has good business credit. Otherwise, you risk cash flow problems.
Slow-paying invoices are a common source of cash shortages. Clients typically pay their invoices more slowly if the economy is at risk of recession. Recessions also increase the chances your invoices won’t get paid and become bad debt.
d) Accelerate client payments
You can improve cash flow by offering clients on net-30 accounts an incentive to pay sooner. A 2% discount if the client pays in ten days is typical. However, the discount is negotiable.
Early payment discounts can work well if you offer them to your best clients. Clients will appreciate these discounts as a way to increase their profits.
Early payments are optional, and clients can opt-out at any time. Consequently, asking for faster payments does not produce reliable results, especially if your cash flow squeeze is severe.
2. Factoring improves cash flow quickly
Companies with a cash shortage due to slow invoice payments should consider factoring. It’s a financing solution that behaves like a receivables-backed line of credit. Factoring allows your company to finance its invoices and get immediate liquidity. You can use the funds to pay company expenses or cover the cost of setting up new clients.
a) How does it work?
Factoring companies usually finance accounts receivable in two installments. The first installment advances around 85% of the A/R. The size of advance varies by industry and risk profile.
The remaining 15% is advanced once the end customer pays the invoice in full. The factoring fees are usually subtracted from this installment. This settles the transaction. Your company can use factoring as often as needed.
Learn more: Read “How Does Invoice Factoring Work?”
3. Advantages
The most important advantage of a factoring line is that it can improve your cash flow quickly. This is the main reason why companies get factoring. However, there are other advantages as well.
a) Easier to get than bank financing
This solution is designed to work with small and midsize businesses. Qualifying for factoring is easier than getting a line of credit or a loan. The underwriting process is simple. The most important requirement is to have invoices from clients with good business credit.
b) Grows with your business
The line is adaptive and can grow with your business. Increasing the line is simple and can be completed in a day or two.
c) Can be deployed quickly
One of the main advantages of factoring over other solutions is that it can be deployed quickly. This is why it’s a well-known alternative for companies with cash shortages.
4. How quickly can you get funded?
Factoring lines can be deployed quickly. Sometimes, the account can be funded in a couple of days. On average, it takes about five days to get funding. There are five general steps to the process:
- Send a full application to the factoring company
- The factoring company underwrites the transaction
- Contracts are signed
- NOA letters are acknowledged by your customers
- Invoices are verified
The first step is entirely under your control. You must return a completed application package to the factoring company before they can underwrite the transaction. Factoring companies can underwrite transactions in a day or so, provided no major problems exist.
Once you have a contract, you control how quickly you execute it. Read the contract carefully and consult an attorney if you have questions.
The last step two steps are entirely in the hands of your customers. Most customers complete this step quickly. However, you should work with your factoring company to ensure the process goes smoothly.
5. Do you qualify?
Qualifying for a factoring line is relatively simple. Your company must meet the following criteria. It must:
- Work with creditworthy customers
- Have quality invoices
- Have invoices that are free of liens
- Not be at risk of immediate bankruptcy
- Not have serious tax problems
6. Long-term strategy
Using financing to handle a cash shortage can work well. However, financing comes at a cost and can decrease your profits. Your objective should be to move to cheaper financing or become self-sufficient eventually.
Factoring should be used as a steppingstone to better options. These options include ledgered lines or lines of credit.
Get more information
We are a leading factoring company and can provide high advances at low rates. For more information, get an online quote or call us toll-free at (877) 300 3258.
Disclaimer: This article should not replace competent financial advice. If your company has cash flow problems, see a professional.