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Do You Need a Small Business Factoring Company?
Many businesses are finding it difficult to secure the working capital needed to finance their operations. The lack of available business credit is one of the biggest concerns in today's economy. Unfortunately, these problems are especially problematic for small business owners, ones who rely upon banks and credit unions in order to finance their operations, finance their inventory and ones who need long-term financing in order to support their plans for growth. However, a number of small businesses are turning to a well-established alternative financing solution, one that allows them to use their receivables in order to establish a line of credit. It's called receivables factoring and it an asset-based financing solution that helps small businesses run their operations, improve their cash flow and reduce their risk.
Factoring Companies for Small business makes more sense, than Extremely Low Interest Rates?
While credit itself is hard to secure, companies that can secure credit are ultimately able to benefit from a low cost of capital. However, if interest rates are competitive, then why are so many of today's small business owners seeing their financing costs rise? Simply put, customers aren't buying as often and when they actually do buy, they aren't paying as quickly as they should. In both instances, the costs of financing increases for small business owners. Inventory has to be financed for longer periods in order to manage uneven business cycles, and receivables have to be financed for longer periods in order to cover delays in customer payments
How Long have Factoring Companies for Small Businesses Been Around?
It's important to understand that receivables factoring is not some new approach to business financing. It isn't a gimmick and it isn't something that is only relegated to a select few industries. It is an asset-based financing option that has a rich and storied history. In fact, it's been a source of financing for businesses for several thousand years. All kinds of companies, in all kinds of industries, rely upon receivables factoring in order to reduce their costs of capital, reduce their financing and improve their cash flow.
What types of companies can benefit from receivables factoring?
Simply put, any company that is having a hard time managing cash flow, is one that can immediately benefit from factoring. Any company that operates in an industry where customers expect extended payments terms, is one that can benefit from factoring. Any company that operates in a high risk industry, one where customer bankruptcies and payment delinquency are high, is one that can benefit from receivables factoring. However, it's not just for enterprises that deal with these aforementioned issues. It's a solution that is open to all companies, regardless of size and regardless of their current financial position.
Why Factoring Companies for Small business is an Asset-Based Financing Option?
An asset based financing option is any financing option that allows a company to use its current assets as a form of business collateral. In most cases, a company's largest assets include the inventory within its warehouse, the equipment and machinery it owns, any large capital expenditures it has financed, any real-estate it has purchased and finally, any customer invoices is has yet to collect on. Receivables factoring is an asset-based solution that allows small businesses to use the liquidity of current unpaid invoices in order to establish a business line of credit.
Companies that use factoring are able to sell their receivable to an outside financing company. That financing company purchases the receivable and owns the right to collect on that receivable from the small business's customer. In return, the small business is provided an upfront cash advance, an advance that is based on a percentage of the receivable's value. The small business gets the capital it needs to finance its operations, while providing the financing company with the right to collect on their customer's invoice. Once the small business's customer pays their invoice, the small business is reimbursed the difference between the initial advance and the customer's final payment. The financing company then charges the small business a transaction fee.
Unlike conventional financing, where banks lend money based on the financial stability of the small business, the factoring company basis its decision to advance the small business capital based on the credit worthiness of the small business's customer. At no time does the small business have to submit financial statements. At no time is there a review of the small business's credit history. Receivables factoring is ideal for those enterprises that don't have an established credit rating, or don't have the financials needed to secure conventional financing.
Success with receivables factoring ultimately comes down to deciding between two main factoring options. One option includes using recourse factoring, while the other includes non-recourse factoring. Both options have different terms and conditions. Both have different stipulations as to the amount of the upfront advance and the amount of the fees charged by the financing company. However, in both instances, the emphasis must be on using factoring the moment the invoice is generated. Early invoices always garner better terms and conditions.
With recourse factoring the small business assumes liability on the receivable. In this case, the small business is able to secure a higher upfront capital advance on the receivable, while covering a lower transaction fee with the financing company. Recourse factoring is best suited to those situations where the small business is very confident in its customer's ability to cover the receivable. In some cases, the advance is can be up to 85 percent of the receivable's value. The benefits include a lower transaction fee and a higher advance.
Non-recourse factoring means the small business assumes no liability on the receivable or invoice that was financed by the factoring company. However, there are limitations in the statute that will not cover charge back issues related to service or product claims. This option is best suited to those situations where the small business is unsure of their customer's ability to cover the receivable. In some cases, the factoring company will buy credit insurance against bankruptcy or a credit default with that specific account debtor. Not all account debtors are eligible for non-recourse and it's not as commonly used in today's receivable financing options. In summary, the only account debtors that are eligible for non-recourse are unlikely to default, and the client ends up paying a premium on credit insurance for the financing.
With conventional financing the small business must cover a daily interest rate on its receivables up to the point where its customers pay their invoice in full. The factoring company operates differently. There are essentially two portions to the costs of factoring. First, most factoring companies charge an administration fee of around 1% to 2% and a daily rate for the number of days the invoice remains outstanding. This administration fee is applied to the receivable's total value. Second, factoring companies provide an option of either a flat fee or a tiered fee. The tiered fee is often tied to the age of the receivable, or put differently, it's tied to the number of days it takes the customer to close their invoice. The advance rate varies depending on the industry and number of accounts submitted which will range from 75 to 95 percent of the receivable's value. This combined rate is called the “effective rate,” and it is comparable to the aforementioned interest rates charged on bank loans and credit lines. However in factoring you have to think of it more like a transaction fee, similar to a credit card merchant that charges a fee to accept credit cards in your business. Factoring fees can range from 0.59% and up to 6% depending on the volume and average size invoice.
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