e-Learning Center

Factoring as an Option

TYPICALLY, SMALL BUSINESSES lead the way out of recession, says Jeffrey Leonard, the CEO of the Global Environment Fund near Washington, D.C., in a Washington Monthly article. But this time that's not happening, and Leonard believes one of the main reasons has to do with restrictions in small-business cash flow.


"Many large companies today have simply announced that as a matter of policy they will be paying their bills late-sometimes as much as four months late," Leonard notes. "This in effect forces small businesses, which really are hurting, to make free loans to big businesses instead of being able to use their working capital."


"Many large companies today have simply announced that as a matter of policy they will be paying their bills late-sometimes as much as four months late," Leonard notes. "This in effect forces small businesses, which really are hurting, to make free loans to big businesses instead of being able to use their working capital."


Experts say small-business owners can respond with a variety of steps, beginning with examining cash-flow options.


Optimizing Cash Flow

In this environment, it's more important than ever that small businesses manage their cash flow as efficiently as possible, says John Barrickman, a Costco member and the president of New Horizons Financial Group, a consulting group for the financial services industry headquartered in East Point, Georgia. "Owners should concentrate on boosting cash flow by improving operating efficiency and cash-management practices."


The first step Barrickman recommends to small-business owners is to determine the total amount of their uncollected accounts receivable: "This represents a large lake in which huge amounts of cash can be trapped." The next step is to examine processes for managing cash.


"Can you use bank tools like lockbox, remote capture and electronic payments to process receipts and collect receivables faster?" Barrickman asks. "Banks offer a broad range of treasury management tools that small businesses can use to increase their available cash." Also take a close look at the flip side: your accounts payable. Lisa Aldisert, the president of Pharos Alliance Inc., a New York City management consulting firm, encourages clients to revamp their payables procedures in order to hold on to cash longer.


"Stretch your payables as long as possible without hurting your vendors, unless you're offered a discount for prompt payment," says Aldisert. "Take full advantage of your 30 days to pay if those are the agreed-upon terms. But don't be late; you want to maintain excellent trade credit."


If one or two large customers have slowed down their payments, this makes it more important to sharply focus collection efforts on your other customers, Barrickman adds. "Does it make sense to hire a part-time employee to call customers and encourage prompt payment? For that matter, can you justify spending 30 minutes a day calling slow-paying customers?"


While doing business with a large corporation can provide a significant sales boost, Barrickman says owners must assess the overall profitability of these sales in light of the potential impact on cash flow: "You've got to make a business decision about whether or not you can afford to carry the receivables."


Factoring As An Option

One option that many cash-starved small businesses are considering to help ease the cash-flow crunch is an alternative financing vehicle known as factoring.


Factoring is a creative financing solution for businesses that don't qualify for traditional bank loans but need a financial boost to help manage their cash-flow cycle. With factoring, businesses sell their outstanding accounts receivable to a commercial finance company (or factor) at a discount. "Instead of waiting up to 90 days or longer to get paid, the business receives most of the cash-typically 70 to 90 percent of the receivable-when the invoice is generated," says Eden. It receives the balance, less the discount, when the factor collects the invoice.


Eden explains, "The improved cash flow derived from factoring benefits a company's relationships with vendors, enables additional growth and helps ease the demands on payroll


Don Sadler is an Atlanta-based freelance writer who specializes in small business.