by Jeff Bell, senior vice president of eCapital
Cash flow is a universal business essential, and often one of the most difficult aspects of getting a business going. A vicious cycle can result when cash flow is weak and your number one priority is to get your new business off the ground – caution and fear outweigh growth and potentially reign in the ability to take on more projects or even make the best decisions for your business. This is such a primary issue because access to working capital commonly relies on external forces, for example vendors and customers who may not necessarily have the same priorities as you.
In fact, your start-up needs are typically in direct opposition of your customers, as each entity works to manage its own working capital requirements. It can be a hard lesson in cash management, sometimes catching a young enterprise off guard. Ultimately, you will pay by having to wait out the terms, timing strategic business decisions based on when cash is expected and making potentially painful adjustments when cash is delayed.
It’s this battle to control the stop and go nature of start-up cash flow that is driving growth in accounts receivable financing, also known as factoring.
Understanding Factoring.
Invoice factoring is a well-established means of generating consistent cash flow. At the same time, it is not well-understood outside its historical sweet spot markets such as publishing and clothing manufacturing. That is changing, and more global arenas like freight, farming, staffing, oil exploration and all manner of manufacturing are leveraging its simplicity as a powerful cash management tool. Today factoring is making a comeback, surpassing more than $3.1 trillion in global annual volume in 2013, a nearly five percent increase compared to 2012.
Factoring is an ideal solution for new businesses because start-ups qualify – in contrast to bank funding, which can be difficult to secure if your business is less than three years old. Application processes and stringent credit reviews can be giant hurdles even for established companies; besides, maybe you just really need cash flow more than you need a costly loan or credit line that will burden your new entity with long-term interest debt. Unlike traditional bank loans, the factor is much more concerned with the credit-worthiness of your customer, whereas bank funding focuses on the credit-worthiness and total assets of you, the seller. Factoring is not a loan – it is the purchase of a financial asset (your invoices) by a factor from the seller at a discount. Because the process is based solely on invoices, it requires no financial review or underwriting and there are no predefined limits to factoring funds. No interest accrues and no debt is added to your company balance sheet.
Anticipating Cash Flow Needs.
Many businesses see growth itself as the answer to better cash flow. Yet, good business and good cash flow are not necessarily the same thing. Just ask any business owner with payroll and operating expenses, who regularly loses sleep wondering if customer payments will come in as needed, on time, every time. Cash flow needs commonly increase in step with new customers or projects – so while winning new business is great for profits, it presents a greater challenge in managing all the moving parts.
For example, how does a cash-strapped firm handle that record-breaking order that finally comes in? Services and raw materials must be purchased to complete the order, causing a very real problem for firms without cash on hand. The order may be lost if your firm is ‘too small’ to handle the business in the meantime, presenting a huge problem for start ups. And let’s assume your new customer is a biggy – of course they are going to pay but they have their process; that likely includes their own cash management operations where their comparatively smaller vendors must ride out long pay terms in order to win business and stay competitive. A business loan could come to the rescue, but for any number of reasons that could be as unlikely as winning the lottery and require a lot more effort. A lengthy application process and stringent credit review are big hurdles, and besides, maybe you just really need cash flow more than you need a costly loan or credit line that will add long-term debt to your company’s balance sheet.
“Banks tend to look backward at where a business has been, loaning against its history as a gamble on its future success,” said Richard Sarif, co-chief executive officer, Capital Partners Services, a provider of private label A/R servicing and portfolio management to business lenders. “Factoring works in contrast to this ideal, providing working capital for growth based on real, current business. There’s a simplicity about it that adds appeal – payment is received and the business stays focused on the project it was hired to handle. The process reduces worry about cash flow, but also reduces aggravation, time and stress related to collecting payments.”
Why Now?
With trillions funded globally, why has factoring remained relatively untapped as a working capital model? Getting paid in advance became negatively associated with firms on the edge of failure, increasing sensitivity to turning over collections to be handled by a factor. This perception, along with what business operators assume to be high costs, until recently kept factoring as a less favored financial option.
That has evolved with the economic climate, now fueling a new look at the factoring process. Business lending rules are far more complex and demanding, competition is fierce and growth is required for survival. Together these challenges mean that working capital is a necessity, and ensuring access to smooth cash flow is recognized as smart business. The billions funded by factoring in 2013 are anticipated to grow, based on consistent average growth of 10 percent annually since 1993.
Working Capital Means Strategic Advantage.
All viable working capital models should be evaluated for your start up, and today should include a look at factoring as a mainstream option. Invoice-based financing is playing a renewed and important role in modern business finance – helping manage operating costs, and ensure that business growth is no longer dependent on what operating capital can be reserved toward winning new customers.
Invoice or accounts receivable (A/R) factoring is a financial transaction where a business sells some or all of its accounts receivables (or invoices) at a discount to a factoring company (or factor), enabling the business to gain immediate access to its cash. The factor advances a large percentage of the invoice value to the business. Upon getting paid by the end customer, the factor pays the balance remaining minus their agreed-upon fees. The business is paid quickly and the factor takes on the role of the accounts receivable department – easing the administrative load and leaving the business to focus on the job itself.
An attorney and alternative-lending specialist, senior vice president of eCapital, Jeff Bell helped pioneer the world of modern-day factoring with his innovative ideas and desire to help businesses achieve financial freedom. With his years of experience, Jeff understands every facet of factoring, helping eCapital fund more than $4 billion while assisting over 9,000 businesses across the U.S. Contact Jeff via email at jeff.bell@ecapital.com.
