Factoring - A Solution For Small or Start-up Businesses

Factoring - the benefits for a small or startup business

When starting a new business it is important that sufficient capital is provided initially to enable the enterprise to successfully establish itself. This capital could be in the form of money provided by the prime movers be it a sole trader, partnership or share capital in respect of a limited company. Additionally a bank loan or overdraft may supplement this capital and leasing may be used to purchase certain fixed assets. A mortgage can be taken out for the purchase of any property requirements. Further capital can be found by approaching a venture capitalist or business angel or perhaps friends and family. However this tends to dilute the prime movers interest in the business resulting in a smaller share of future profits.

All the above will contribute finance for the establishing of a business in order that it can initiate its trading activity. Hopefully if it has got its sums right it will have sufficient working capital to successfully go forward. In working capital we mean adequate cash flow to pay wages to staff and make purchases from suppliers enabling the production and selling of goods or services. If it sells direct to the public i.e. as in a shop, the cash flow will come in the form of cash paid immediately by its customers for those goods or services.

However if it is trading business to business it has another problem cash flow wise. It is normal practice in the UK to offer credit terms to your customers ranging from 7 days say for employment agencies to 90 days in the printing industry. The result is that when a sale is made the cash is not immediately available for the payment of wages and suppliers. Therefore the business will need to have raised an additional amount of capital in its initial stage to fund this or seek further funding so that it can continue to trade. Also it is normal for a young business to be seeking rapid growth in its initial stages of development to establish itself in its marketplace but when offering credit terms to its customers it will need more and more working capital to finance these sales. This is almost certainly to be further exacerbated by customers not paying on time – the terms say are 30 days but the customer takes 60 to pay. For a small business this can be a huge headache as prompt settlement of debt is vital to the development of the business and often the prime movers find themselves more and more drawn into chasing up outstanding invoices when their time should be better spent running other areas of the business.

The enterprise has a stark choice now – does it stand still in order to work at the level its working capital can support or look for further funding so as to grow the business. It is often vital for small businesses to continue to grow to achieve their profitability targets. Stay at the same level and risk making a loss or grow the business and risk a cash flow shortage by over trading. Further loans could be sought from a bank but these are normally finite and therefore as growth continues further funding is needed. Banks often require security i.e. personal guarantees to increase an overdraft or approve further loans and also seek evidence of trading results such as management accounts. Also there is still the problem as credit sales continue to grow of getting the customers to pay on time – in fact as turnover grows so does this problem. More and more time needs to be spent on chasing up overdue accounts and if you don’t chase there’s a good chance you won’t get paid. Is there a better solution?

The answer is YES there is – FACTORING

Factoring could well be the answer as unlike other sources of finance it is expressed as a percentage normally providing up to 85% of the value of each invoice initially with the rest paid when the customer pays. This means it is flexible in the sense that as the business grows so the funding from factoring grows providing adequate working capital to pay wages and suppliers in a timely manner allowing the business to continue to grow without the fear of over trading.

What about the burden of the ever increasing and time consuming need to chase customers for overdue payments. Is there a better solution?

The answer is YES there is – FACTORING

Factoring not only provides finance against the sales ledger but also has a service element attached to it where the factor will take over the administration of the sales ledger on behalf of your business so relieving the prime movers from the onerous task of chasing up customers for payment and therefore allowing them to do what they do best – running their business. For a business to be successful you do not want your prime mover bogged down in administration – you use accountants to collate financial records, solicitors to look after legal matters, etc. so why not use a factoring company to outsource your credit control. They will maintain the sales ledger on your behalf sending out regular customer statements setting out when invoices are due for payment and following-up on any invoice not paid on time. By offering a professional collection and credit control service cash can be collected in a more timely manner thus improving your cash flow and reducing pressure on your working capital demands.

They can also advise on the credit worthiness of both your existing and new customers. In order to minimise bad debts potential customers should always be checked out for credit worthiness however this is still no guarantee that they won’t go bust and leave you with a bad debt. This leads to another potential problem to a small business looking for rapid growth – as it offers more credit to more customers so increases its bad debt risk. One bad debt can turn a profitable business into a loss making business and create a major cash flow headache. Is there a better solution?

The answer is YES there is – FACTORING

Factoring also offers bad debt protection if it is required. Providing the business operates within the limits set by the factoring company they can receive 100% protection against bad debts. This is a major comfort to any small business looking for expansion and it is surprising that most enterprises do not take up this part of service offered by factoring companies.

To sum up there are major benefits to a small business in factoring when looking for finance to grow the business both in the finance it provides and the support it offers providing a sales ledger administration service and bad debt protection.