April is Financial Literacy Month in the United States—and it provides an excellent opportunity to review and improve your business finances. First observed in April 2004, Financial Literacy Month is intended to educate people on the principles of finance and planning for a secure financial future. It’s a topic as important for businesses as it is for individuals.
Top financial challenges for businesses
Businesses face many financial challenges, from getting started and attaining profitability to navigating the financial demands of various growth phases. According to data from the US Census Bureau, there were over 32.6 million small businesses as of 2018 (the most recent data), and 99.7% of them have 500 or fewer employees. Small businesses power the United States economy, but they face particular financial challenges. Staying in business is one of the biggest: although 80% of small businesses make it through Year 1, nearly half are out of business by the end of Year Five, according to the US Chamber of Commerce.
Why? For nearly half, it’s lack of funds—difficulty accessing the working capital needed to meet short-term liabilities and operational expenses, to keep the lights on, people on staff, and the business running. Limited or insufficient cash flow leads to many other financial problems, including missed business opportunities, too much debt, failure to raise capital, poor marketing, missed or late bill payments, and the mixing of personal and business finances.
Businesses need access to working capital. Without it, they risk their business growth—and sometimes the business itself. But it’s not always easy to obtain working capital, especially for small, young, or rapidly growing businesses. Traditional lending like bank financing—loans and lines of credit—often have requirements that young or new businesses cannot meet. Or, their terms and repayment schedules make it difficult for small businesses to meet them and remain profitable and growing. Other options may not be better, putting small or young businesses at risk of predatory lenders or at the mercy of venture capital investors who take an equity stake in a growing business.
Business owners can benefit from thinking outside the bank for their working capital financing during Financial Literacy Month and at any time all year. Here is what business owners should know about an often-overlooked financing option: factoring.
What is factoring?
Factoring, also known as invoice factoring, is a financing method based on the purchasing of accounts receivable. A factoring company purchases the unpaid invoices of a business for services already rendered or products already purchased. The factoring company advances funds to the business and then follows up with the customer for payment. When payment is made, the factoring company then pays the business the balance of the invoice less a fee.
Who benefits from factoring?
Businesses of any size can benefit from factoring when they need access to cash but do not qualify for bank financing. These include situations in which a business has been turned down for bank financing. These reasons can be customer concentration, credit score concerns, insufficient assets or net worth, or being a start-up or new company without a long enough track record to satisfy the bank’s lending requirements.
Factoring is an option when delayed invoice payment, a large order, or other unexpected circumstances constrain a business’s access to working capital—at any stage, and for businesses of any size. Established businesses may face challenges when they land new accounts and must fund the rapid growth that can come with large new orders. Factoring can also benefit businesses recovering from a financial setback, helping them regain profitability. In addition, businesses can also realize benefits from factoring by outsourcing management of accounts receivable to a professional factoring company. This can relieve pressure on staff or reduce accounting errors that may delay payment, ultimately helping a business get paid more quickly and be more efficient overall.
When should I factor my invoices?
Put simply, factor your invoices when the gross margin on the next sale is greater than the cost of factoring, or when your business will save money with trade discounts, reduced administrative costs and collection fees that offset the cost of factoring. Another smart reason to factor is when landing new business—and funding it—through factoring will increase your bottom line.
How much does factoring cost?
The fee varies by the amount of time it takes to collect the receivables. Typically, the fee ranges from 2-5% of the invoice’s face value. Some factoring companies (like Prairie Business Credit) will only collect the fee when you receive your payment.
Does factoring affect my credit rating?
Factoring invoices gives businesses access to cash to pay bills, pay down debts, meet operational expenditures, and make investments in growth. This can help businesses improve their credit ratings and take advantage of discounts and better terms from suppliers. Ultimately, these actions can help to accelerate a business’s ability to obtain bank financing in the future.
Looking to protect and grow your business with access to working capital? We can help. Prairie Business Credit is a national working capital provider to young, growing, or recovering businesses. We offer accounts receivable financing, purchase order financing, and equipment financing. Our company serves both as a trusted financial resource and consultant to entrepreneurs dedicated to building their businesses and ensuring their success.
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