Diverse sectors have struggled for a very long time to get their clients to pay for their orders by the due date listed on the invoice.
You’re afraid that charging excessively large late fees will discourage clients from placing future orders, yet you need the money owed to you to keep your firm thriving.
So, what is the remedy?
Cash flow issues can influence practically every size and type of organization. As the process of launching and maintaining a new firm is frequently uncertain, unstable, and fluctuating, cash flow difficulties provide a significant challenge for small enterprises. Therefore, You need to be smart while expanding your business with cash flow solutions and accounts receivable process options. So, think before you equip yourself with the necessary working capital to expand your business operations or capacity.
In today’s article, we shall focus on the pros and cons of accounts receivable financing to assist you in determining which financial solutions are best for your organization.
Pros of Accounts Receivable Financing
Companies are not required to take out high-interest loans to address unexpected liquidity needs. Therefore, accounts receivable finance enables a company to meet its needs without issuing loans. On the other hand, Accounts Receivable financing is sometimes more expensive than conventional financing alternatives. Therefore, caution is required before obtaining this strategy.
Saying this, we can say that there are numerous advantages and disadvantages to accounts receivable funding, making it difficult for someone new to the process to determine whether this funding is worthwhile. So, let us now uncover them.
Here are some pros:
1. Minimal Credit Requirements
With invoice financing or factoring, the quality of your invoices is the primary concern of the finance provider. Your credit score is irrelevant if your clients have good credit and make timely payments. It is because your invoices serve as collateral, and the lender’s downside risk is that your clients will not pay.
Therefore, if you can demonstrate that you have dependable customers, you can acquire invoice financing even if your credit history is not stellar.
2. Rapid Cash
Your business may require immediate cash for various reasons, including purchasing raw materials, renovations, or payroll. In addition, cash originates from clients and consumers who purchase your products and services. However, if these payments are delayed, your company must find alternative means to meet these costs. Therefore, accounts receivable factoring might be useful if you have a pressing need for cash but are having difficulty borrowing from banks or raising funds through the issuance of debt or shares.
Believe it or not, receiving cash within five to ten business days is feasible. However, certain instances may be within one to two days.
3. Time Saved
Supposedly, time equals money. But unfortunately, time is always a matter in the business world, and as a busy business owner, you cannot afford to spend even one minute. With the accounts receivable process, you can save time and effort that would otherwise be spent collecting customer payments. In addition, most factoring contracts include collecting money from the actual clients, so you’ll have one less thing to worry or think about as a busy business owner.
By outsourcing accounts receivable services to a third party, you can devote your resources to more profitable and productive aspects of your organization, such as sales. Many companies will take care of collecting the money, allowing you to dedicate the time and resources you would have spent on collections to making money and expanding your business.
As a business owner, you will easily understand the significance of devoting time and energy to sales, marketing, and client growth. Therefore, consider accounts receivable finance as a means to alleviate yourself of some difficult tasks.
4. Financing Discretionary
Unlike term finance, the accounts receivable process allows business owners to determine the timing and quantity. When cash flow is sufficient, you can hold on to your receivables and wait for clients to pay on schedule. Conversely, when cash flow is poor, you can sell the necessary number of receivables to satisfy anticipated expenses.
You may incur a cost for receivables management, but it is typically far less than a loan’s monthly principal and interest payment.
Cons of Accounts Receivable Financing
Your clients’ history of paying payments on time or as near to on time as feasible may impact the interest rate you pay, depending on the lender you work with. Moreover, depending on the specific lender, you may have a lengthier contract term than you anticipated – in some situations, between two and three years. Therefore, ensure you comprehend the length of the contract and inquire whether shorter terms are offered.
Also, please familiarize yourself with typical factor financing errors to prevent them.
Sometimes, your customers/clients may believe you rely on the accounts receivable process because you’re experiencing difficulties with cash flow. As a result, it may make people hesitant to engage in longer-term transactions with you.
Now, let’s consider the possible disadvantages of accounts receivable finance.
1. Sigma
This deception is more reputation-based than it is financially-based. Some business owners, but not all, feel that accounts receivable finance are stigmatized. No, this stigma is unrelated to the perception that factoring is ‘unfair,’ as business factoring loans are an established, practical, and legal method of financing for firms. Rather, this stigma stems from the fact that some individuals may believe that if your business relies on receivables financing from a loan institution, it is a ‘negative indicator’ that your company is struggling and may soon close its doors.
When clients learn that they will no longer pay you directly but will instead pay a receivables financing company, they may conclude that your company has cash flow issues or is in danger of going out of business. Ensure that you engage openly and proactively with your clients to explain the issue and alleviate any concerns they may have. Ultimately, you’re in it for the long haul.
2. Cost
According to the saying, nothing in life is free. And as a wise business owner, you know that funding is never provided without cost. Even though it may be vital to have rapid access to cash, factoring may be more expensive than loans. As their fee, factoring companies typically retain between one and four percent of a receivable. In addition, they can (and will) charge interest on the cash advance, usually at least the prime rate plus one or two percentage points.
Although it may not seem like much every month, the annual interest rate can exceed 30 percent.
3. Higher Costs
While obtaining capital for your business may be a rapid option, it may come with greater expenses than other business loans. Remember that failure to repay the loan within the specified period will increase the total amount owed.
4. Dependency on Customers
One of the main advantages and disadvantages of invoice financing is its reliance on customers. On the one hand, your approval odds are not as dependent on your credit history as with other financing forms.
On the other hand, acceptance can be difficult if your consumers have low credit scores or shaky payment history. Additionally, if approved, you will pay a higher factoring cost. In addition to the higher base rate, consumers who pay late may incur additional fees.
Conclusion
Accounts Receivable Financing helps boost a company’s liquidity. Generally, the cost of this type of financing is higher. Thus a company should always undertake a cost-benefit analysis to determine the optimal financing method. Utilizing Accounts Receivable Financing, sudden working capital needs can always be satisfied.