Running a small business can be very rewarding, but it can also be very challenging too, mainly due to cash shortage issues. Even if the small business’ sales are up, it doesn’t necessarily mean that they actually received the cash at the time of the sale. Cash from sales that are made today may not be collected until 30, 60, or even 90 days later. This can create frustration as well as financial hardship if plans aren’t put into play to combat this problem, especially in the construction industry. If you find yourself in a similar situation, construction factoring might be a great solutions. However, please see below some strategies that other small business can implement to avoid potential cash shortages in the future and better manage their cash.
Factoring and Accounts Receivable Financing
Businesses that have a significant amount of accounts receivables look forward to cash flowing in over the next few months. However having accounts receivables on the books doesn’t necessarily address immediate cash needs. Factoring is one way to address this issue, whereby businesses sell their accounts receivables or invoices at a discount to a third-party. This not only provides some financial breathing room, but it also serves as a backup plan and a means to get cash into the company immediately to satisfy other debt.
However there’s a price to pay for this type of transaction, when invoices or Accounts Receivables are sold at a discount, business owners receive upfront cash for an amount less than the Accounts Receivables.
For example, if a company has $50,000 worth of Accounts Receivables but they’re not due for an additional 30, 60, or 90 days, then those receivables can be sold at a 10% discount, or for $45,000, that will be paid to the factor and $50,000 from the combined receivables. The factor, or the third party will then become responsible for collecting the debt based on the terms previously agreed to by the business. This type of transaction is usually a win-win for all parties involved.
Many business owners may be wondering what the going rate is to factor Accounts Receivables. Usually this rate is negotiable based on a few components. Some key negotiating areas consist of:
- Having a large volume of invoices where the total sum equals a sizable amount
- Having a significant mix of credit worthy customers that outweigh those who aren’t as creditworthy and
- The average payment cycle