As our economy continues to recover, the next generation of entrepreneurs are emerging, creating new opportunities and filling the marketplace with energy for new commerce. This is truly a breath of fresh air after a prolonged recession and continued recovery. One thing that hasn’t changed much over the last 20 years is the lack of education and understanding of how to cash flow the growth of a new business. Even those who graduate with a master’s degree in business administration (MBA) will confide that within the degree is very little time spent on business financing in general, and especially alternatives to bank financing.
When a business is considered startup (less than two years old), financing options are limited and the borrowers are often discouraged when they try to ask a bank for a loan. A poll published last year suggested some don’t even try to ask at all.
Cash flow is essential for a business to grow. A retail business is mostly cash and credit card transactions, which means cash flow isn’t an issue, unless they are unprofitable. If a business has to bill for their services, and they are billing other companies, then they have to wait 30, 60 or 90 days for payment (the average is 45 days). Now, we all know that we are expected to pay our bills every 30 days. Here lies the cash flow dilemma; we pay our bills 12 times per year and we get paid eight times per year, if we are good at collecting.
Let’s say that a business is really thriving and experiencing good growth. Maybe they even doubled their sales. Now they are really feeling the pinch. Instead of being ABC Service Company, now they feel like the bank of ABC Service Company. This pinch causes them to pay their bills late, electing to pay payroll taxes late, and sweating over Friday payroll. The eventuality of a lack of cash flow means overdraft fees, unpaid taxes, compromised credit and sleepless nights. The crazy thing is a business can be profitable with a negative cash flow and go out of business.
There is an amazing tool that most entrepreneurs don’t know about that can help an emerging young, rapidly growing company. It’s called factoring.
The largest form of factoring transacted today is via MasterCard/Visa. Retail merchants accept your credit card as payment because they have a contract with MasterCard/Visa. This contract allows the retail store/restaurant to expedite its cash flow by receiving the amount you charged – minus a small discount – within 72 hours after the transaction occurs. This gives retailers a steady cash flow, which is helpful in replenishing supplies.
When there are cash flow issues for a business-to-business transactions, in which credit cards are not applicable and a business must bill for their services, factors are used. Using accounts receivable as collateral, a factor will expedite the rate you are getting paid, usually within 24 hours after a job is completed instead of the typical 30, 45 or 60 days. Factoring is a great tool for a company that doesn’t yet qualify for a traditional credit facility.
In factoring, the collateral used to borrow against is the accounts receivables. The reason they can do this for a new business or any business that is experiencing credit difficulties is that it is based on the credit worthiness of your customers. In other words, factors purchase your credit-worthy accounts receivable at a small discount and convert your invoices (sales) into immediate cash. Factors can provide a cash flow solution for companies that have experienced negative retained earnings and/or poor profits. Banks will only lend money against a company’s proven profitability. Typically, a business has to provide a minimum of two years of tax returns, profit-and-loss statements, and balance sheets supporting their profits.
Factoring is not a loan. There is no debt repayment, no compromise to your balance sheet, no long-term agreements or delays associated with other methods of raising capital. Factoring allows you to use your own hard-earned assets to create cash for the growth needs of your company.
Factoring can be used to quadruple the size of a business over the course of a year or two. The availability of cash is directly related to how much product or services are sold. It’s really simple.
As a business grows in size and monthly volume they can graduate into an operating line of credit or a revolving line of credit. These credit lines are also offered through private companies that do not have the same underwriting standards as a traditional bank.
In summary, there are many alternatives to bank loans or lines of credit. For all those emerging or credit challenged business owners who feel discouraged when they try to get help, factoring invoices is just one. The costs associated with insufficient cash flow are far greater than the cost of factoring. There are many things that can be done to control costs with a little training.
Suzy Oubre, principal of Alliance Commercial Credit Group, has been assisting businesses for more than 20 years. She specializes in alternative financing and debt restructuring. Oubre can be reached at firstname.lastname@example.org.