There are many different options a small business owner has to consider for short-term funding sources. However, there are some major considerations and potential pitfalls with many of these options.
Credit cards are a very risky option when addressing short-term gaps in cash flow between work completed and payments received. With high-interest rates, late penalties and their potential to harm personal and business credit reports, they should always be used with extreme caution.
Bank loans are also a potential problem for a small business. Most small businesses will have difficulties even qualifying. Not to mention, the application process is difficult and may require accounting services and weeks of gathering information and preparing reports. The loans require repayment of both principal and interest, which can eat into future profits.
The Factoring Option
To avoid lengthy applications and repayment issues, many savvy business owners choose factoring accounts receivables as a funding option. This is not a loan or credit; rather it is an advance on already issued invoices that are yet to receive payment.
The factor buys these accounts and provides full account management including collecting from your customers. At the same time, once approved, you will receive funding of up to 80%, typically within days. There is no repayment as your customers will be paying directly to the factor. In this way, factoring accounts receivables allows your business to choose the invoices to factor to meet your cash flow requirements.
The factor will withhold a small amount, typically 20% of the value of the invoices purchases. Once your customer completes payment, the factor deducts the fees and forwards the residual from the withholding to your account, ending the transaction.
The fees and costs for factoring accounts receivables need to be clear, easy to understand and transparent. Make sure there are no hidden fees, costs or penalties and ensure there are no volume requirements with the agreement.