Cashflow is the lifeblood of any company, and so it stands that irregular flows of finance can spell potential disaster for a company that fails to implement the systems and processes necessary to maintain a healthy flow of funds.
For many businesses, cashflow shortages can be attributed to the lengthy period debtors take to pay an invoice. It is not uncommon for many businesses to wait up to ninety days to receive payment.
Late payments can often trigger a series of expensive measures for businesses trying to operate on a limited cash flow. Often they are forced to offer profit diminishing settlement discounts to encourage prompt payment and chase payments. Alternatively many resort to debt or equity to generate the necessary flow of funds.
The exposure borne by small business from late payers is forcing many operators to reduce their bottom line by up to seven per cent. While this practice can be an effective short-term solution, it is financially onerous over longer periods.
For instance, a business that turns over $1 million annually and offers a four per cent payment discount stands to lose more than $40,000 each year. If this amount was recouped and invested at a decent rate of interest over five years, the business could accrue up to $230,000 to reinvest in the firm.
Considering small business contributes more than one third of the nation’s GDP and 15 per cent of the export market, it is clearly economically unviable for the SME sector to carry the responsibility for slow payers. In response, many SME operators are taking a leaf out of the UK market, and adopting alternative cashflow management measures to avoid the significant pitfalls of fund shortages.
One solution is factoring. Factoring is a cashflow management facility that allows a business to receive up to 75-90 per cent of the value of its unpaid invoices within 24-48 hours. It is a solution favoured by operators who require fast access to cash, but do not want to diminish their equity holdings, nor add to their existing debt.
The use of such a facility enables operators to draw down on the business’ aggregated invoice total. This means the debt ceiling imposed is completely aligned with the business’ performance and growth.
Factoring agents can also offer administration support relieving proprietors from the tedium of chasing up late paying creditors and enabling them to devote more time to the growth of their business.
The key benefits of using factoring include:
1. Reliable cashflow.
In times when market uncertainty prevails, SMEs are particularly exposed to fluctuations in demand and the risk of debtor default. Factoring helps SMEs accommodate fixed overheads such as rent, staff and tax by injecting a volume of cash into the business based on the aggregated value of its outstanding invoices.
2. Confidence in decision making.
A dry cashflow curtails the courage and conviction necessary for strategic development activities such as future planning, securing competitive trade terms, honouring substantial orders and pitching for new business opportunities. A company held hostage to its cashflow cannot expand and succeed.
3. Autonomy and flexibility over rigid bank terms.
Banks and financial institutions offer a myriad of cashflow solutions that secure debt on the value of the SME proprietor’s assets, though these arrangements are rigid and require a long-term and inflexible commitment from SME operators. Factoring on the other hand enables SMEs to vary funding arrangements in line with business performance and growth.
4. Professional debt management.
Factoring offers SMEs the added benefit of debt collection and administration, in some cases eliminating the expense of employing a full time or part time account clerk. Factors are efficient and diligent non-bank financiers who understand the SME market and can objectively manage bargaining debtors.
5. Time management.
Outsourcing debt management creates time for business operators to focus on operations and development opportunities.
6. Bottom line protection.
Often SME operators offer generous settlement discounts that reward debtors if payment is received within the specified trade terms. This can result in thousands of dollars every year being effectively absorbed by the SME’s profit and loss statement.
Businesses most suited to factoring are those exposed to cyclical demand for outputs, but who require constant inputs to keep their business operational, such as raw materials, staff and other day-to-day expenses. These businesses are generally manufacturers, business service providers and wholesalers.
Businesses using factoring, can stay in tune with account payment status online, and can draw down from their accelerated cashflow at rates competitive with banks.
Where the business chooses the factor to administer its debtors ledger on its behalf, additional fees will apply. As with any other source of finance, business operators looking to adopt factoring as a finance solution should explore their options to the extent they feel confident their choice is an informed one.
Businesses considering factoring also need to understand that they carry ultimate responsibility for any bad debts that may not be recovered. Also, where the factor takes over the debtors ledger, businesses should take care to maintain strong customer relations and stay abreast of accounts that may require sensitive handling or be vital to the business. After all, good client relations are integral to the success of any small business, and regardless of the debt management system in place, operators should never lose sight of their responsibility in this quarter.
For any company choosing to use a factoring facility to help manage their business it is important that they implement effective procedures for debt recovery.
The following points outline the fundamental procedures that should form the basis of a debt recovery management system.
Always credit check potential customers. Winning a new customer is always exciting but make certain they are credit worthy before you commit time and resources to working with them.
Agree terms in advance. Agree terms of payment with new customers as part of the sales process. Make sure they understand that the price of goods is linked to the credit terms you offer and make it crystal clear that you have a legal right to claim interest.
Inform your debtors. If you have habitual late payers, contact them and discuss better payment options. In addition, foster good working relationships with your customers and suppliers so that it's easier to resolve payment problems when they arise.
Send out invoices as you dispatch goods. Do not delay sending statements and invoices out on time.
Keep clear documentation. Make sure you send accurate invoices/statements to the right person, at the right place, at the right time and state clearly the date payment is due.
Collect your money on time. Have a collection timetable and stick to it. If a promised payment fails to arrive, chase it again straight away. For further piece of mind ask them for a cheque or receipt number.
Communicate effectively. Ensure existing customers are quickly made aware of any due invoices. Re-check the credit worthiness of any customer who continues to withhold payment.
Keep clear records. Any correspondence with customers should be logged, even telephone conversations.
Have the right attitude. Don't be embarrassed about discussing money. Remember, if you've kept your part of the deal you have the right to be paid. Be polite but firm.
Review your credit checking procedures. Aim to run credit checks on your clients on a bi-annual basis. If there is a change of ownership of any business you should also reassess their creditworthiness.
Understand your rights. Research your legal rights in relation to receiving payments from a debtor.