Many small businesses struggle with cash flow in the early years. One way to improve your cash flow is by factoring your debts.
When you factor your debts the factoring company gives you up to 85% of any outstanding invoices straight away. They also take the burden of collecting your debts away from you. For this service they charge around anywhere between one and three percent of the invoice value.
I used factoring in the late nineties when I was struggling to manage the growth of my packaging business. Some of my biggest customers were taking a long time to pay their invoices and as their business increased the only way I could raise money to keep supplying them was through factoring.
Initially my fee was 2% but after one year the factoring company reduced it to 1.5%. This fee not only paid for the collection of the debt but it also insured it so that if any of my customers went bust I would lose a maximum of five hundred dollars.
The way this works is that before you supply any new customer you submit their details to the factoring company and in return they give you the amount of credit you can offer. All debt supplied up to that figure is insured and anything above it is not. I rarely supplied any customers over their credit limit.
I factored my debts for approximately 5 years. The factoring company only actually made profits from me for 3 of those five years. The other two years they ended up having to pay me more for the insurance payouts than I actually paid them in their fees!
The only problem I had was when they were slightly too strict trying to collect my outstanding invoices! I almost lost a customer but after a little bit of delicate negotiation we managed to save the day.
Factoring has a got a really bad name in the industry but I do not understand why. It’s a great way to boost your cash flow if suddenly you get more orders than you can handle or your business starts to grow fast. It really only works well when the value of each invoice is high.
If your average invoice value is less than a couple of hundred dollars you will struggle to find a factoring company that will accept your debt. The main reason for this is that they take a small percentage of each invoice and at this level their percentage works out to such a small figure that it is no longer viable for them to make money from you.
As usual with all these types of articles the standard rules apply. Do not base your decision to factor your debts based on this article and always seek expert advice from your accountant first before entering into a factoring agreement.
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