Every company that is growing and doing well eventually experiences cash flow problems. Actually, the most common cash flow problem happens because customers pay invoices in 30 to 60 days. Companies can afford to offer terms and wait for payment – at least initially. But if your company is growing quickly, it will eventually run low on cash. And then the problems start.
The simple solution to this problem is to get financing. However, the current marketplace offers few solutions to help midsize companies that are doing reasonably well. These companies are growing and well managed, but they can’t qualify for a line of credit just yet. Often, these companies are placed into products that can help but are better suited for smaller or less-established companies.
Let’s look at the two main financing options
Large companies usually have access to commercial lines of credit. These lines offer tremendous flexibility and do a great job at improving a company’s cash flow. However, getting a line of credit is difficult. Banks and lenders have tough qualification requirements for both the company and the borrowers (personally). Credit lines are designed to help companies that have impeccable financial statements and plenty of assets.
On the other hand, companies with a short track record (or in turnaround mode) are directed to use invoice factoring. Factoring allows companies to leverage the commercial credit of their customers and provides them with funding against slow-paying invoices. The solution is easy to get and can be set up quickly. However, factoring companies implement a number of controls and verifications to ensure that every invoice is accurate. Some controls involve contacting the payers regularly to verify payment details. These controls can be cumbersome for clients and their customers.
A better option – sales ledger financing
Sales ledger financing is an alternative that fits companies that have outgrown factoring but can’t qualify for a line of credit. The solution offers many of the benefits and the flexibility of a line of credit, without having the redundant controls that are built into many factoring programs. As a result, sales ledger financing is an ideal option for midsize companies that are doing relatively well and have good financial controls.
Sales ledger financing vs. invoice factoring
Sales ledger financing has a number of advantages over accounts receivable factoring, especially in terms of flexibility, cost, and ease of use.
1. Funding process: The funding process for a factoring transaction requires some paperwork. To get invoices funded, you must submit a legal document called a Schedule of Accounts, which lists every invoice you want to fund. Additionally, you must submit each invoice that needs funding, along with any backup documentation that verifies that the services/products stated in the invoice have been delivered.
Sales ledger financing is a lot simpler. All you have to do is submit a copy of your sales ledger, which can be easily generated by your accounting or invoicing system.
2. Funds advance percentage: All facilities that use accounts receivable as collateral will fund only a percentage of the invoice. By the way, this is the case for almost any facility that uses accounts receivable as collateral.
The percentage of funds advanced for both ledger financing solutions and factoring is similar. Most companies can finance 80% to 85% of their sales ledger. Exceptions are made for transportation and staffing companies, which can often finance up to 90% of their ledger.
3. Pricing structure and cost: The cost of a sales ledger financing line is less than that of a comparably sized factoring line. Also, the facilities are priced differently.
Factoring lines usually have a fixed cost per increment of time such as x% per 5 days or y% per day. This cost is charged based on the face value of the invoices.
Sales ledger financing pricing is a hybrid of the pricing methods used for factoring and lines of credit. There is a funding cost based on WSJ prime rate plus a small add-on. This approach is often referred to as prime + x% and is charged daily on the funds employed. Additionally, there may be a small maintenance fee charged based on the size of the sales ledger.
4. Invoice verifications: As part of their funding procedures, factoring companies verify the majority of invoices they fund. Invoice verifications ensure that all invoices are accurate and error free. Verifications must be done prior to funding. Invoices that take longer to verify could delay the transfer of funds.
Sales ledger financing, on the other hand, takes a softer but equally thorough approach. It uses a verification process similar to that of a line of credit, which doesn’t always involve contacting customers regularly.
5. Provider: In general, invoice factoring is offered by factoring companies. Ledger financing can also be offered by factoring companies, though many banks offer those facilities as well.
Summary: Advantages of sales ledger financing
Both invoice factoring and sales ledger financing solve the same problem: they improve your cash flow by allowing you to finance invoices from clients who pay on net 30 to 60 day terms. The main advantages of sales ledger financing over factoring are:
1. Better client experience: The most important advantage is that sales ledger financing is easier to use than factoring – for both you and your customers. You can get funded by submitting only your sales ledger. If you were factoring, you would have to submit a schedule of accounts, a copy of each invoice, and backup documentation for each invoice.
From your customer’s perspective, sales ledger financing also offers a better experience. They do not have to deal with conventional factoring verifications. This benefit can be very important if you have sensitive client relationships.
2. Better rates: Both factoring and sales ledger financing offer competitive rates. However, sales ledger financing rates are slightly better because the product is offered to companies that have outgrown the needs (and restrictions) of a factoring facility.
3. Stepping stone to a line of credit: If used strategically, a sales ledger financing program can provide your company a stepping stone toward better and cheaper financing. It’s not unusual for clients to upgrade to a borrowing base certificate program, such as an asset-based loan, or even a full-fledged line of credit.
Who qualifies for sales ledger financing?
Sales ledger financing is available only to companies that meet certain criteria. The company must:
- Have annual sales of four million dollars or more
- Be able to provide accurate financial statements
- Have good sales backup documentation
- Be profitable, or have a short-term plan to profitability
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