Working capital is the life blood of any business. Without it, the ripple effects can cause headaches and eventually cause the entire operation to come crashing down. Bills don’t get paid, payroll is late, unpaid taxes grow with penalties and interest. This is why prudent business owners secure outside capital to help smooth out the peaks and valleys of their incoming revenue.
When a business provides a service or sells a product and offers payment terms to their customer, they are becoming a lender. The customer owes money and the company is offering credit. Sometimes a business will leverage those loans or receivables to borrow working capital to grow and pay their bills. There are various methods these days to put those receivables to work, but this article is focusing on the difference between a conventional line of credit and invoice factoring.
If the company looking to borrow has 2 – 3 years of profitable tax returns, and their financials show there is enough profit margin in their sales, they might qualify for a conventional line of credit from a bank. This is the preferable method above all other forms of financing due to the cost of funds being the least expensive – providing that the line limit is enough to allow growth to occur without constriction. This is a critical component when considering going after less costly capital. Will the size of the credit availability allow for future growth?
But for the purposes of illustrating why a company might consider working with a factoring company instead, let’s suppose the business can qualify for the line of credit from a bank. Once this happens, the business is essentially self factoring their revenue to provide the fuel for growth. In other words, to properly use a conventional line of credit, the company should be writing checks to pay bills with the anticipation that orders will be paid for and that income will go back into the bank line to pay down the outstanding amount. Money out, money back in. It’s is an absolute critical component of properly using a line of credit. Too often, a business will take money out to pay bills and then pay some of it back when a customer check arrives. This activity slowly eats away at the line of credit until the day when the spread between the outstanding balance and the credit limit on the line makes the loan vehicle almost useless.
The point is – there is an internal discipline required to properly utilize a conventional line of credit. Probably most companies with a seasoned CFO and controller will be able to handle this distinction without trouble. But many small businesses are focused on other aspects of growth and lack the financial expertise to properly control the use of a credit line.
For this reason plenty of businesses find that working with a factoring company offers the safety of gaining access to working capital without worrying about ending up with a debilitating long term liability down the road. The factor is making advances on invoices as they are created and the customer payments are retiring the advances in a timely fashion. There are many benefits for using factoring as a financial service and supplying financial discipline is definitely one of them.
We have many clients who find the process of having a proper credit analysis of customers, verification the customer acknowledges the outstanding amount and unlimited credit availability on a regular basis provides them with the most beneficial method to sustain a growth cycle. Using OPM requires discipline and factoring can fulfill this requirement.
Gary Honig
Company: Creative Capital Associates Factoring Co. Sept 18, 2015