How to Improve Your Cash Flow by Factoring Receivables

Few things are more concerning to business owners than encountering cash flow problems. These problems impact all areas of the business, especially sales and operations. This situation often creates a financial “vicious-cycle” that is hard to reverse.

In this article, we explain the most common cash flow problem that afflicts small businesses. More importantly, we provide three solutions you can implement to fix this problem permanently.

Slow-paying customers create cash flow problems

Many small and growing companies have cash flow problems for one simple reason. They must offer 30-day payment terms to their clients. Offering terms allows commercial and government clients to pay your invoices in 30 to 60 days.

Customers are usually unwilling to negotiate on this point. You have to give them terms as a condition of getting the contract. Otherwise, your clients will go to one of your competitors. This situation puts you in a difficult place.

You can sustain offering terms to customers as long as you have a large enough cash reserve. The reserve must be able to cover your expenses while you wait for your customers’ payments.

Using a reserve, however, can expose you to problems. What happens if your sales grow? This growth could use your reserves and leave you exposed. Alternatively, what happens if clients delay payments? Before long, you run into financial problems.

Three steps to solve the problem permanently

The right way to solve this cash flow problem permanently is to use a stepped approach. You start with the first step and move to the next one only if your problem isn’t solved. Each step builds on the previous one.

Step #1: Improve invoice collections

Most small companies get into financial problems because they are sloppy in their collections. This careless approach to collections adds delays to their already slow cash flow. Consequently, clients who would have usually paid in 30 days may end up taking longer to pay.

This problem can be solved easily. It’s a matter of using a good invoicing and collections process diligently. You have to ensure that:

  • Contracts are written correctly
  • You give terms only to clients with good commercial credit
  • Clients are invoiced according to the contract
  • Clients get all needed paperwork to pay the invoice
  • You follow up promptly if a client is late
  • You handle disputes quickly and professionally

Improving your invoicing and collections process will likely handle most slow-paying customers. Good invoicing and collections often solves your cash flow problems. It also has the advantage of costing little or nothing to implement, while yielding long-term results.

Step #2: Offer early payment discounts

If your collections are working well and you need clients to pay even faster, offer an early payment discount. Early payment discounts provide clients with an incentive to pay sooner. The incentive is simple: give clients a discount.

Discounts are implemented in different ways. The most common strategy is to give clients a 2% discount if they pay within ten days. Otherwise, they can pay in 30 to 60 days without a discount.

The discount offer is negotiable and can vary by client. Negotiate the lowest possible discount that convinces your clients to pay early. Common discounts include:

  • 1%/10 – net 30
  • 1%/15 – net 60
  • 2%/10 – net 30
  • 2%/15 – net 60

One challenge of early payment discounts is that they are optional. Clients use them at their convenience. They can stop using them at any time. Unfortunately, many clients stop using early payments during tough economic times – precisely when you need fast payments the most.

Step #3: Use accounts receivable factoring

Having a good invoicing and collections system and offering early payment discounts are great strategies. However, they don’t always fix all your company’s cash flow problems. If you experience that situation, consider using accounts receivable factoring.

As its name implies, factoring allows you to finance invoices from slow-paying but creditworthy customers. Factoring improves your cash flow, providing the funds you need to cover expenses, take on new clients, and grow the business.

How does it work?

Factoring companies finance your receivables in two installment payments. The first installment, called the advance, covers 80% to 90% of the invoice. The factor deposits the advance to your bank account soon after you submit the invoice for financing.

The remaining 10% to 20%, less a fee, is deposited to your bank account once your customer pays. This second installment settles the transaction. You can use receivables factoring as often as you need. For more information, read “How does factoring work?

How much does it cost?

The cost of factoring receivables varies based on your financing volume, industry, and risk profile. In general, rates range from 1.15% to 4.5% per 30 days. Rates can be pro-rated in various ways to accommodate your customer payment schedules.

How do you qualify for receivables factoring?

Qualifying for accounts receivable factoring is easier than qualifying for conventional financing. Transactions are not structured as loans. Instead, the factoring company buys your accounts receivables (i.e., an “asset”) and pays you upfront.

The most important qualification requirement is that your clients must have good commercial credit. Your client’s credit is essential because the transaction depends on their payment’s reliability.

Additionally, your accounts receivable must not be encumbered by any liens. Liens are created by loans, different types of financing, or tax debt.

This solution is available to clients of all sizes. Factoring is often used by new and growing businesses that are building a track record. It’s also used by larger companies that need a flexible solution that does not have restrictive covenants of conventional credit lines.

Get a quote

We are a leading receivables factoring company and can provide you with competitive terms. For more information, get an online receivables factoring quote, or call us at (877) 300 3258.