Young colleagues raising hands at the business meeting in office.

Managing cash flow is one of the biggest headaches when running a small or medium-sized business.

Even if the company is making sales and a decent profit, unreliable and late-paying customers can make predicting your cash position nearly impossible. As a result, collections take up a significant amount of time, as does the constant challenge of deciding which vendors will get paid, and dealing with those that don’t.

There are various ways that businesses can fund their accounts receivable. A company might maintain a significant cash reserve, for example. But holding that cash could limit the business’s ability to invest in expansion. Alternatively, a company could apply for a bank loan or overdraft. But banks are often reluctant to lend to small businesses. The company would need an excellent trading track record and credit rating.

The other option when you have cash tied in accounts receivable is invoice factoring. But is factoring the right choice for your business?

What is Invoice Factoring?

Factoring gives businesses access to the cash they have locked up in their accounts receivable. The factoring company buys the sales invoices at a discounted price, so factoring is also sometimes called invoice discounting.

The cost of sales invoice factoring is usually lower or comparable to the cost of borrowing. However, factoring is not lending, so it has no impact on the company’s balance sheet. Hence, factoring is known as off-balance-sheet financing.

Related: The Pros and Cons of Invoice Factoring for an Expanding Business

When is Factoring Not Right for a Business?

A business must have unpaid invoices to use the services of a factoring company. So retail outlets, for example, would be unable to use this method of finance. Any business that sells products or services on a cash with order basis would also not be suitable for factoring.

There are also some types of invoices that factoring companies will not finance. You might find that you cannot factor payments in advance or deposits, for example, and some companies will not finance subscription or annual support and maintenance invoices.

Another good reason not to factor sales invoices would be that you don’t usually have a significant accounts receivable balance outstanding. Suppose most of your credit customers pay their invoices within seven days, for example. In that case, the cost of factoring might outweigh the benefit of having the cash available faster.

Circumstances Where Factoring Would be Beneficial

Considering the above conditions, any business that grants credit to customers and has a substantial rolling accounts receivable balance—like 30, 60 or 90 days—may benefit from sales invoice factoring. This applies to companies of all sizes and most sectors.

Factoring used to be thought of as a financing option of last resort. But that is a misconception that is simply not true. Factoring is a cost-effective financing method that many successful companies, large and small, use to free up working capital. So, why do so many small and medium-sized businesses choose to factor sales invoices?

Related: Nine Common Misconceptions About Invoice Factoring

1. Release Working Capital

Factoring companies usually pay their clients within 24 hours for factored invoices. So, instead of waiting for the usual 30-90 days to receive the cash, companies have access to most of the money generated by sales invoices almost immediately. This release of funds increases the liquid working capital available, which eases cash flow problems and provides more cash for reinvestment in the business.

2. Creates Predictable Cash Flow

Small and medium businesses often suffer from the unpredictability of cash flow as much as they lack funds. The money is there is to run the company smoothly, but it is tied up in unpaid sales invoices. And, when you cannot be sure when sales invoices will be paid, it becomes challenging to plan for future purchases and paying existing creditors. Factoring removes this uncertainty by ensuring that the bulk of the money from sales invoices is immediately available. So, it becomes much easier to predict cash flow and run the business.

3. Reduce the Collection Burden

Late payments are inevitable when you grant credit to customers. And, if you don’t follow up overdue customers with statements, phone calls, and letters, cash flow will suffer. So, collections can become a time-consuming and costly task for a business with a significant number of customer accounts.

When you factor sales invoices, the factoring company takes responsibility for collections, so your employees are freed up for more productive work. You also don’t have to deal with making what can sometimes be difficult phone calls.

4. Increase Profit

As mentioned above, the cost of factoring sales invoices can be lower than the interest you would pay on a loan or overdraft. But there are other potential cost savings to be gained, too.

Having more cash in the bank could allow you to take advantage of volume discounts on the purchase of raw materials, for example. The factoring finance fees might also be less than the early settlement discounts that you currently offer customers as an incentive to pay on time.

5. Fund Expansion

One of the dangers of rapid expansion is that you run out of cash to fund the growth. The sales graph shows a healthy upward trend, but you lack the money to pay for the next batch of stock to sell. This situation, which is known as overtrading, can be exacerbated by late-paying customers. The same problem can arise when a single large order is received. However, factoring invoices will ensure that cash is readily available to fund the growing demand and so the business can continue expanding.

The Bottom Line

So, with a few exceptions, sales invoice factoring is a funding option for most businesses that run accounts receivable. Factoring frees up working capital, makes cash flow more predictable and easier to manage. If any of the above scenarios strike a chord with you, it might be worth exploring factoring further.

Your Questions Answered Quickly

Whether your business is thriving and you can’t keep up, or you are waiting on clients to pay, Universal Funding can help your growing company. Call us at 800.405.6035 or complete our rate form today to learn more about invoice factoring and how it can improve your company’s cash flow.

About Universal Funding

Universal Funding is a nationwide invoice factoring solutions leader, supporting growth-focused businesses with scalable factoring solutions. With its invoice factoring, payroll funding, and purchase order financing services, Universal Funding provides clients with the working capital needed to grow and support their businesses without taking on new debt. Ranked as one of the nation’s top invoice factoring companies, Universal Funding provides cash flow financing for businesses all across the United States.

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