Data presented by Business Insider concludes roughly 82% of small businesses fail due to cash flow problems, while about 29% outright run out of cash. These contribute to the reality that half to fail within the first five years. These statistics can be hard to face, but in accepting them, small-business owners can create strategies to overcome hardships and build an organization that’s built to last.
Cash Flow Issues Can Sink a Business
Small businesses are unique in that they typically run at full capacity. They have just enough people, materials and equipment to serve the needs of their existing customer base. This can be a good thing because it means the business isn’t wasting resources, but at the same time, it doesn’t take much to create an imbalance. For example, if demand for the product or service goes up, the business may not be able to meet the demand, which can ultimately hurt the company and lead to unfulfilled orders and dissatisfied customers. If customers are slow to pay, the business may not have enough cash on hand to pay its bills. If equipment breaks or repairs are needed, the business may not be able to afford to get things up and running again. Businesses face these types of situations regularly, but not all are prepared to handle them.
Banks Don’t Help 50% of the Time
Most small-business owners, when faced with financial challenges, anticipate being able to take a loan out from a bank. Unfortunately, per data from the 2017 Small Business Credit Survey, almost a quarter of those who apply for loans and lines of credit are denied, while more than half don’t receive the full amount they need. The biggest reasons banks might deny an application: insufficient credit history (36%), insufficient collateral (35%), too much existing debt (30%), and low credit scores (27%). That means most small-business owners have no choice but to find other ways to improve their cash flow issues. Unfortunately, many turn to personal credit cards or using their own homes as collateral. That means they’re putting themselves and their families at risk, which is particularity worrisome given the high failure rates for small businesses. Factoring is another option that can help, but people don’t always understand what it is or how it works.
Factoring: Risky or Not?
Invoice factoring involves selling invoices to a third party. The other party pays the small business right away and then collects payment from the customer. The concept is straightforward: it solves cash flow issues and can ease the labor-intensive process of billing and collecting your clients.
What to Remember About Factoring
Factoring companies charge a small fee for each invoice purchased, but the amount will vary based on the company, the volume of invoices processed, the value of the invoice and other variables. In addition, the factoring company doesn’t always purchase all the invoices. They assess the risk of the company that owes money and tend to purchase invoices that will be paid by low or medium-risk companies.
The Upside to Factoring
Factoring companies are less concerned with the credit history of the business owner and his or her business than they are about those paying the invoices. This means that even those who are not approved for bank loans and credit lines can often still qualify for invoice factoring. It can also make cash flow more predictable, give businesses a cushion of working capital and streamline the billing process. Additionally, factoring companies often provide customers with more ways to pay their invoices, making the process simpler for them and improving customer service.
Assessing Your Risk: The Bottom Line
Ultimately, it’s wise to spend some time getting to know your business’ numbers. The biggest “risk” associated with factoring is that you could potentially factor invoices that good-paying clients would have already paid in a timely manner, but at the same time, you’re saving time and money by not dealing with the invoicing or collections process. You should evaluate what you’re currently spending on invoicing and collections as well as what you’re losing by not having customers pay in a timely manner and not having a cushion of capital to fall back on.
If you’re need of cash flow and back office services, and you may not qualify for traditional financing, factoring may be the solution that prevents your business from being part of the 50 percent that closes.
Learn More About Factoring
If it sounds like factoring could be right for you and your small business, get a free online factoring assessment or download our complimentary invoice factoring guide to learn more about how it works.