Cash Flow Statement Is Based On Cash Basis Of Accounting Is the Check Really "in the Mail"? Stop Playing the Waiting Game

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Is the Check Really "in the Mail"? Stop Playing the Waiting Game

Many business owners wait anxiously in front of their inbox every day to find out how they can run their business that day. If the long-awaited checks come in, that’s great—they can pay suppliers, meet payroll and tax obligations, and maybe take advantage of growth opportunities. If they don’t come, it can mean another sleepless night wondering when all those checks that are “in the mail” will actually materialize.

This “cash flow crunch” is especially acute for fast-growing companies in industries where customers tend to stretch their accounts payable over 30 or 60 days. The fact is, more businesses fail due to lack of cash flow than lack of sales. Slow accounts receivable turnover can literally bleed a business to death.

Offering open account terms to customers may be part of your cost of doing business, but have you ever considered how much it’s really costing you? If you wait 30 days to get paid, you can turn your profitability into a bigger deal just 12 times a year. Imagine what a 90 or 120 day cash conversion cycle does to your cash flow and ability to grow!

Of course, another risk associated with open accounts is the risk of not getting paid in general. In their quest for growth, many business owners offer payment terms to customers with less-than-stellar credit. Even owners who try to be diligent when it comes to credit checking new customers often lack the training or expertise to spot red flags that may indicate bad credit risks.

A factoring solution

One solution to both challenges is a long-established process that has recently received renewed attention as the banking credit crunch took hold: factoring. How do factoring services work? Commercial finance companies (known as “factors”) purchase outstanding receivables from companies at a discount, usually between 2-5%. Thus, the company receives payment already 24 hours after issuing the invoice, instead of 30, 60 or even 90 days later.

To better understand how a factoring service works, let’s compare it to what happens when you use a credit card to pay for a retail purchase:

Anyone with a consumer credit card has gone through an application process and been pre-approved for a certain spending limit based on their credit and payment history, employment status, etc. With this card, an individual can acquire goods and services from a multitude of different product and service providers.

Let’s say you are treating a client to lunch. You hand the waiter your credit card when he brings the bill, and he promptly disappears behind a felt wall to “check your credit” by swiping the card through an electronic terminal. If the card is approved, you can “sign the bill”, paying for the service provided – your meal. Your next contact with this transaction is when your credit card statement arrives, recording the transaction for your verification. You then pay the “credit provider”, which in this case is the bank that issued the card.

But what happens at the end of the restaurant? At the end of each business day, the restaurant submits “pre-authorized invoices” (ie credit card receipts) for that day to the bank for payment to take effect and “sells” them at a discount. The restaurant does not receive 100 percent of the face value of the bills, but a predetermined percentage in exchange for allowing customers to use the credit at their establishment. The restaurant usually receives the funds from their bank the next business day.

A factoring service does exactly the same thing as a bank in this case, but on a commercial basis. A factoring service buys a receivable from a business at a discount and is responsible for collecting it, just as a bank buys a credit card transaction from a discount restaurant and is responsible for collecting payment from the customer. Business customer payments are sent directly to the factoring service’s secure mailbox, while restaurant customer payments are sent to the bank’s mail lock.

The benefits go beyond cash flow

Remember that the benefits of factoring services go beyond faster receivables turnover and improved cash flow. To start factoring services, it performs all customer credit checks to help identify bad credit risks and based on these checks, sets appropriate credit limits for each customer. Debt collection, customer credit monitoring, and providing online account information are some of the other valuable service factors. In essence, a factoring service can be a full-time business credit manager, accounts receivable officer, and collection agency all rolled into one.

Often, the accelerated cash flow that results from factoring is the catalyst that helps businesses move to the next level of growth or success. Factoring services can also be used by business owners planning their exit strategy as a means of strengthening their balance sheet in preparation for selling the business or acquiring new partners.

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