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Entrepreneurial Corner - 8-15-07

How Small Businesses Avoid Financial Disaster

By Donovan Moorhead

Small business owners and business managers typically struggle with collecting on accounts receivables. While many businesses can get away with requiring payment upfront on products or services delivered, other businesses cannot. When dealing with corporate clients, a small businessperson must generally agree to 50% upfront and 50% on completion of the work, in order to get the job. Other business managers have realized that if they offered financing to their clients, they could increase the number of sales that they can expect to receive.

Although extending credit to a business' customers is good for business, most small- to medium-sized businesses cannot afford to float their customers' payments indefinitely. In other cases, product or service suppliers do not have enough cash-on-hand at their end to float their customers' payments for more than a week or two.

And then there are those times when the customer who received the credit from the supplier could not pay on time. Sometimes, those invoices remain unpaid for more than 90 days, and the supplier has to commit time to chase payment from the customer. If a business has dozens of overdue invoices, the company may have to employ one person just to ensure that invoices will get paid. This may increase the cost of operation for the business at a level that makes it difficult to continue doing business without raising prices.

Not very many businesses can afford to let one or two large clients go without paying. Non-payment of invoices could lead to the supplier having its own financial problems, which could lead to past due bills or in the worst-case scenario, the closing of the supplier's business.

Planning Ahead To Prevent Financial Disasters

Most new business owners have the idea that the only way they can acquire cash they need to float client invoices or business growth is to go to a bank and ask for a business loan. Others think that the next best bet is angel investors.

But, the truth is that when dealing with banks, most will not talk to a company that has less than twelve months of operating records. Other banks require three years of operation before they consider giving the business a loan. And when they are willing to consider a loan application, they generally require one-to-three years of records to substantiate the loan.

Venture capitalists or angel investors are much the same as the banks when it comes to proving a track record to ensure the viability of the business. The additional downside to using the venture capitalist or angel investor is that in most cases, the investor requires a percentage ownership of the business and a higher percentage rate in order to supply the money needed to grow the business.

For Most, The Best Option Remains Unrealized

There is actually a different kind of financing out there that few people realize exists. It is called Invoice Factoring.

Invoice factoring brings a new twist to the challenge of financing businesses. Instead of having to go to a bank or an investor and lay out the records of the supplier, the supplier turns their invoices to a third-party financing company, also called a factoring company.

The invoice factoring company analyzes the credit of applicant business' invoiced clients. The factoring company, based on the size of the invoice, the invoiced clients' credit and other factors, will make a determination as to the likelihood of that client paying the invoice and charge a factoring rate based on this analysis.

When the supplier turns an invoice over to a factoring company, the factoring company will pay the supplier 80%-90% of the invoices' face value, usually within 24 hours to seven days. The supplier will now have this money on hand for maintaining their operations.

The factoring company will take over the role of the accounts receivable department of the supplier. They will maintain contact with the client and ensure that the invoice will be paid in a timely manner.

When the client makes payment in full, then the factoring company will extract their service fees for handling the invoice, which is called the invoice discount rate. Once the factoring company has received their fees, then it will send the remaining cash received to the supplier.

Cost Benefits

Many small-, medium- and large-businesses consider the invoice factoring company to be a vital component of their business model.

When considering the cost of hiring people to maintain accounts receivables and collections, the cost of the factoring service is small in comparison to the alternative. Most factoring services only charge an invoice discount rate of 2%-5%, depending on the many factors that go into their analysis of an invoice.

One of the greatest benefits to the supplier is the ability to acquire cash immediately, to keep their business running smoothly while their customers delay payment. Two advantages are gained by getting partial cash payment upfront. First, the supplier can remain in good standing with its own creditors, because it is able to make its own payments on time. Secondly, the supplier will not have to sweat whether a customer will pay in 30-, 60-, 90- or even 180-days. Getting the customer to pay on time becomes the responsibility of the factoring company.

If the supplier were to get a loan from a bank, the supplier would be looking at paying an interest rate in the range of 5%-15%, based on the credit rating of the supplier. These costs could easily exceed the cost of the factoring service in very short order.

One Less Worry

Business owners and managers have enough to worry about already, without having to worry about when a client will pay for services that are rendered.

The invoice factoring company can provide a product or service supplier with the capital they need to stay afloat, during those rough spells. Businesses, who employ factoring companies, have a more stable and predictable business model and tend to survive longer than businesses that do not.

Simply put, the factoring company gives the business owner the flexibility to do what he or she does best... grow his or her business.

About the Author:

Donovan Moorhead writes about commercial finance and business management. If you operate a staffing company, security guard services company, or any other kind of service company, you could very well benefit from our accounts receivable factoring service company. Download the FREE EBook "Growing Your Company Without Debt" from DFS Factoring to learn how Invoice Factoring may be right for your company at: http://www.dfsfactoring.com or (800) 954-0012

Article Source: thePhantomWriters Article Submission Service

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