In today’s economic environment, it is an understatement to say it is challenging for a small business owner to obtain traditional bank financing or increase his or her current loan commitments. Banks have been tightening their credit standards during recent years and will continue to do so for the foreseeable future. Credit lines are being reduced, and capital to fund growth and new business opportunities is very limited unless you are willing to give up equity, which still is very difficult. Even businesses that have had strong relationships with their banks for 10-plus years are having trouble renewing their loan facilities on an annual basis.
Where can today’s small business owner find the capital necessary to keep his or her business going, take on new growth opportunities as they pre-sent themselves, keep vendors current and meet weekly payroll? One answer is accounts receivable financing.
What Is It?
Accounts receivable financing, or factoring as it’s historically known, is a way to fund working capital fluctuations and cash-flow needs of a business. Although it still is relatively unknown in today’s mainstream financial world, factoring has been around for centuries. It has played an important role in business dating back to the pre-1400s.
No matter what you call it, factoring, accounts receivable financing, A/R funding or growth capital is a way to utilize a business’s accounts receivables to finance its cash-flow needs. Funding is provided to clients based on their accounts receivable balances and invoices generated today, though the invoices may not get paid for 45 to 90 days or longer.
Let’s assume a remodeling business has $50,000 in accounts receivables due in less than 90 days. Most factors (privately held finance companies) provide an advance rate of 75 to 85 percent of the invoice amount, depending on industry and underlying credit review. In this example, the remodeling business would be able to borrow up to 85 percent of its $50,000 in receivables, or $42,500.
Let’s further assume the invoices are paid in 60 days. The factor will have set up a lockbox account it controls to receive payment. The $42,500 that was advanced 60 days earlier is paid back, leaving a balance due back to the remodeling company of $7,500, less the factoring fees. Factoring fees typically are 2 to 4 percent per month, depending on the overall risk as determined by the factor. Each factoring transaction is invoice specific, rather than an overall credit line as offered by banks.