One of the greatest challenges of starting and growing a software development company is managing your cash flow. To many software developers, financial management may seem trivial or even simple. They are adept at developing complex technical solutions for clients with difficult business problems. Why, then, should managing finances be difficult?
Most software development start-ups do not plan for the fact that their customers will not pay for their services immediately. Rather, customers often pay based on milestones. And, even then, the payment does not come as soon as the milestone passes through quality assurance. Instead, large corporate clients pay their invoices in 30 to 60 days.
Costs add up
While your clients are paying slowly, your costs continue to add up. Your employees – software developers, project managers, and quality assurance engineers – need to be paid regularly, regardless of when your invoices get paid.
Unless you have planned for this contingency by building a cash reserve, you could run out of money and into problems before the project ends. This problem is common for small software development shops.
Can you ask for faster payments?
One way to solve this problem is to ask your customers for faster payments. You may be able to get faster payments if you offer customers something in return, such as a 2% discount for a payment within ten days. However, this strategy has two challenges.
First, if you start asking for quick payments, some clients may become concerned about the financial viability of your company. Second, this strategy does not guarantee good cash flow. Since quick payments are optional, rather than mandatory, your cash flow remains unpredictable.
Finance your invoices
An easier way to solve this problem is to improve your cash flow with factoring financing. Basically, the solution finances your invoices from slow-paying but creditworthy commercial clients. This solution gives your company immediate liquidity that can be used to cover important expenses, like payroll.
Most transactions are structured by purchasing the invoice in two instalments. The first instalment – the advance – is provided as soon as your client accepts the work, or project milestone, for which you are invoicing. The advance often covers 80% of the value of the invoice, though this amount varies.
The second instalment covers the remaining 20%. It’s paid once your client pays the invoice in full, on their usual terms. The fee is often discounted from this payment. You can learn more by reading “What is invoice factoring?”
Acceptance documents help the process
It’s usually a good business practice to have a client review your work and sign off on an acceptance report. This step can be done as part of the quality assurance process and helps ensure that your client is satisfied with your services. It has the added benefit of making the invoice verification process flow faster, which enables the factor to pay you quickly.
Is factoring right for you?
Determining if factoring is right for you is fairly simple. Although the factoring line is very flexible in terms of limits, it can only help companies with cash flow problems due to slow-paying invoices. Generally, the solution works well if the following are true for your company:
- You have creditworthy clients
- They pay their invoices in 30 to 60 days
- Their slow payments are causing cash flow problems
Unlike bank solutions that have fixed limits, factoring lines can be very flexible. The credit limit is often determined by the creditworthiness of your clients and the diversity of your invoices. The line is adaptive and can grow to match your increased sales, as long as your company meets the funding criteria.
Most invoice factoring lines are priced by discounting a percentage of the gross invoice value. Generally, the discount ranges from 1.5% to 3% per 30 days, based on your company’s risk profile.
Get more information
We are a leading factoring company in Canada and can provide software development firms with competitive terms. For information, get an online quote or call (877) 300 3258.