Why Would a Company Sell Their Receivables?

A company would sell their receivables for a simple reason: to improve their cash flow. Having good cash flow is essential if you want to run a successful business. You can have a great product/service and excellent profit margins, but if your cash flow is bad your business will suffer. As a matter of fact, many profitable businesses have serious cash flow issues.

There are a number of reasons how a business could get into cash flow problems. One of the most common reasons is that they have to offer payment terms to their customers (i.e. net-30 terms). This uses up their available cash while their income is tied to slow-paying receivables.

The Problem: Offering Net-30 to Net-60 Day Terms

The biggest problem of offering net-30 or net-60 day terms to clients is that it affects your cash position. You have to pay for delivering your product/service, and then wait one to two months to get paid.

Meanwhile, you still need money to pay for ongoing expenses to run the business.

When it comes to offering net-30 terms, small business don’t have much of a say in the matter. Most companies, especially larger ones, pay their invoices in 30 to 60 days. It is in their contracts and is usually non-negotiable. You just have to offer terms if you want to work with them.

This puts you in a financial catch-22. You want to grow your business and take on new clients. But if you offer terms, you run the risk of running out of cash.

One way to solve this problem is to sell your accounts receivable.

Selling receivables improves cash flow

Companies can improve their cash flow effectively by selling their accounts receivable to a factoring company. They factor waits for your A/R to be paid, while your company gets immediate cash.

Factoring companies usually buy your accounts receivables using two installment payments. The first installment is called the factoring advance and covers about 80% of the value of you accounts receivable. This is funded as soon as you submit the invoice.

The remaining 20%, less the factor’s fee, is refunded once your customer pays their invoice in full. That settles the transaction. Most companies that use factoring, sell all or part of their receivables on an ongoing bases. This ensures they always have cash-at-hand to pay expenses.

However, accounts receivable factoring is not for everyone. The solution costs more than conventional financing options. It works best if gross margins are at least 15%, though higher is better.

Learn more about accounts receivable factoring.

Why not use regular financing?

You can accomplish the same results using conventional financing options, especially with a business line of credit. You could draw funds from the line of credit to pay for business expenses, in an amount similar to your A/R.  They, pay back the line as your client pay you.

In principle, this works very well. It should be a consideration if you can meet the banks underwriting requirements. However, it has two potential drawbacks.

Qualifying for a line of credit is a lengthy and complicated process. Banks work only with companies that are well-collateralized and can show a positive operating history . Unfortunately, most small businesses can’t meet the  collateral requirements.

The bigger problem is that lines of credit can be inflexible if you are growing quickly. Increasing the limit of a line of credit requires that you repeat part of the underwriting process. This process can be long depending on the circumstances.

Factoring receivables has an advantage because the line adapts to your sales. It increases as your qualified sales grow. Furthermore, the line can be used as a short term solution, which is usually not the case with lines of credit.

Need accounts receivable factoring?

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