Learn how accounts receivable factoring can provide your small business with quick access to capital, and potentially at costs lower than those associated with a bank loan.
Most small businesses, especially those in their initial years, tend to have limited access to capital. Undertaking activities such as gaining market share and developing innovative products/services, all while incurring monthly operational expenses, makes a small business vulnerable to experiencing cash shortfalls.
Fortunately, there are ways small businesses can gain quick access to capital. Below we discuss the concept of accounts receivable factoring and how it can aid in satisfying a small business’ financial needs.
What is accounts receivable factoring?
Businesses often make credit sales whereby customers receive goods/services at the time of sale but pay for them at a future date (normally 30-90 days). Although this strategy may enhance customer loyalty and allure prospective customers to buy from the company, it limits the amount of company’s cash on hand. This in turn can lead the company to forgo any unforeseen expansion opportunities that may arise, or maybe even face the inability to pay bills as they come due.
One approach to alleviating such distressful outcomes is accounts receivable factoring. Accounts receivable factoring involves a business selling its accounts receivable invoices to a factoring company (known as a factor) and receiving in return the amounts owed by its customers; the factor then directly collects the invoice amounts from the business’ customers. Factoring companies normally charge a discount fee of 1-2 percent of accounts receivable invoices and can make funds available to the business within 24 hours.
Accounts receivable factoring can be a better alternative to bank loan
Taking out a bank loan is amongst the most common ways small businesses seek to access capital. However, small businesses, especially those in their initial years, often don’t qualify for a bank loan. This can be due to weak credit history, operations instability, and frequent incurrence of losses.
Nonetheless, even if a business is somehow able to secure a bank loan, it becomes obligated to loan repayments and possibly large interest payments (depending on interest rate) spanning several years.
In contrast, accounts receivable factoring averts many of these obstacles. Since factoring companies are normally able to make the accounts receivable funds (less a discount fee) available within 24 hours, this provides a significant boost to the business in satisfying its financial obligations. In addition, with accounts receivable factoring the small business also avoids the potential hardship associated with making loan repayments and interest charges.
All said and done, every business’ situation is different. While one business might benefit more from a bank loan, another might be better-off with accounts receivable factoring. Therefore, it is imperative that a business owner undertakes due diligence and chooses the option that mitigates financial difficulties and nurtures business growth.
For professional advice contact Alpha Accountzy, Accounting & Tax Solutions.
