The primary challenge of running any business is to keep a consistent cash flow running. In fact, some businesses are more vulnerable than others to cash flows problems. It’s a common dilemma for small and mid-sized companies as they usually find themselves lacking enough working capital to fill a second large order when they have already fulfilled the first one and awaiting payment.
Even more problematic is companies that rely on one or two large clients for their revenues have limitations in their cash flow solutions. Often, they struggle to successfully balance their accounts receivable with on-time customer payment. In this exact context, getting a bank loan is very critical because bankers or lenders are less likely to approve the funding as a consequence of the lack of a diverse client base. Therefore, client concentration or single client invoice factoring can be a vital solution when dealing with this kind of cash flows problems.
What is invoice factoring and how does it work?
Invoice factoring also referred to as accounts receivable factoring or AR factoring is a transaction in which a business uses its outstanding invoices as collateral in a financing agreement. This agreement is with a third party financial company known as a factoring company. Companies do this in order to free up the capital that is stuck in unpaid debts. Thus, rather than waiting 30 to 90 days so as to receive payment, companies can choose to sell their invoices to a factor who will provide them with an equal amount of a reduced value of the unpaid accounts receivable as an upfront payment. This way, companies can quickly build up enough cash flow to handle new orders and the day to day activities.
For example, if a Wine and Spirits company is looking for a funding solution and hold creditworthy invoices worth $150.000 they can choose to factor them and get same day funding. The factor can offer to provide up to 90% upfront payment of their value, meaning $135.000. In due time, the factor will collect the money from the liable customers according to the initial terms of the invoices and return the remaining $15.000 minus the agreed service fees.
Invoice factoring can be a great solution for any business ineligible for a bank loan or that has already consumed its credit line. In fact, it is an even better solution for companies that depend on a single client only to generate revenues. These companies have unique needs because their situation is more critical. They usually have less funding options and more pressure to fulfill orders. Hopefully, AR funding can quickly and efficiently provide working capital to businesses. Even to those that have a single client or client concentration. This is through credit protection and AR management.
Here is how it works:
• Your company submits a single invoice to the factor
• The factor verifies the invoice and gets you simple credit qualifications
• You receive an advance, up to 90% of the invoice value
• Approval can be in as little as 24 hours as your personal credit score isn’t considered
• No payment of upfront fees and enjoy a fast application process
• Your business adds no additional debt
What is a cash in advance loan?
When your business decides to factor its outstanding invoices, the factoring company advances to you up to 92% of the value of the invoice in as little as 24 hours. When its due time and the factor collects the money, your business will receive the retained reserved balance, minus fees. The advance cash rate usually depends on the industry as well as the factor with whom you choose to work with. Also, your customer’s credit history, among other criteria, help define the advanced rate you will receive. If your company averages $100.000 monthly in accounts receivables but your customers don’t pay until after 30 days, factoring can ensure you receive the cash against those invoices so that your business can hold a part of that amount, 90.000 if the rate is 90%, earlier than the supposed time.
How to choose the factor that best fits your business’ needs?
Once you have decided to opt for AR factoring as a funding solution, choosing a traditional or new-age factoring company can seem a little difficult. The different long-term contracts including vague terms, funding rates, various fees and minimum monthly funding amounts can happen to be very confusing. Therefore, you can look into these criteria to take the most optimal decision:
1. Transparency in Rates and fees
If your factor shows transparency in his rates and fees, he is most likely to be the right one to work with. Invoice factoring companies will often have different fees that can be broken down as follows:
- Underwriting fee: Usually meant to cover the actual expenses in closing your deal i.e. background check and UCC filing/ release.
- Discount fee: Usually a one-time percentage fee of total purchased invoices.
- Early termination fee: In case you decide to terminate your contract earlier than agreed on, you will most likely be charged a flat fee beyond the buyout.
- Misdirected payment fee: In case your customers pay you instead of the factor, you will be charged a percentage of the invoice value that has been received by you.
- Your factor should also bring to your attention their method of charging their rates as some would pro-rate the factoring fees in the first funding month while some would charge you a full month’s worth.
Any factoring agreement would bring along a number of fees, the most important is to find a factoring company that will be open and honest from the outset about what they will charge you for their services.
2. Flexible terms
Getting a factoring contract on the right terms is very crucial for your business. You need to understand your long-term needs before taking a decision. Your business could be cash flow sufficient after 12 months, so why get yourself into a long-term contract? Therefore, it is safer to go for a term that is 6 to 12 months and renew it whenever needed. It is important for your business to have a scapegoat as well; in case you have to negotiate any early termination fees.
3. Industry expertise
In order to decide which factoring company will work best for you, you need to find one that is familiar and has direct expertise about your field. The factor needs to understand your needs so as to provide you with the right continuous service. Industry experience is a main criterion and your factor should provide you with a proven track record of success.
4. Customer service
Email and telephone check-ups are a must along with potential face to face meetings when required. Factors need to understand you and your customers in order to be reflective of your business and provide the best possible customer service and care.
What are the benefits of single client factoring?
Managing cash flow can be a hustle when you are a concentrated client business. Factoring can provide you with a number of benefits stated as follows:
- Based on your customer creditworthiness, not your own credit;
- Can be customized to fit your working capital needs;
- Provides free back-office support;
- Factoring is not a loan, a meaningless debt on your balance sheet;
- Funding amount can grow as your receivables grow.