Strong sales figures don’t always translate into a healthy cash flow. When you make more sales, you need more working capital to pay your suppliers and process new orders. Even profitable businesses can struggle with liquidity while waiting for customers to pay.
“Poor cash flow is the primary reason for business insolvency in Australia.”
– Kate Carnell, Australian Small Business and Family Enterprises Ombudsman
In 2019, 51.2% of business failures in Australia were due to inadequate cash flow. Many businesses use Debt Factoring to cover cash flow gaps caused by extended payment terms and late-paying customers.
How Does Debt Factoring Work?
Debt Factoring is a funding solution that enables businesses to get paid faster for the products and services they have already sold. You can use your outstanding invoices to get an immediate cash injection.
Rather than waiting 30+ days for your customer to pay, you can submit the invoice to a Debt Factoring company. The factoring company will then provide a cash advance of up to 95% of the invoice value upfront.
When the invoice is due, your customer pays the factoring company, and they transfer the remaining balance of the invoice to you, minus a fee.
Debt Factoring Step By Step
Step 1: You invoice your customer as usual after fulfilling an order.
Step 2: You submit the invoice to the factoring company.
Step 3: The factoring company provides an immediate cash advance of up to 95% of the invoice value.
Step 4: Your customer pays the invoice.
Step 5: The factoring company pays you the remaining balance of the invoice less fees.
Why is Debt Factoring So Effective?
The problem for many businesses is that their customers are trying to manage their cash flow too. It’s rarely in the customer’s interest to pay for goods and services early, so the seller has to wait to be paid, causing a cash flow gap.
Debt Factoring helps businesses better manage their cash flow by getting paid faster for the goods and services they have already sold. It’s especially beneficial for companies that need to support working capital during periods of rapid growth.
You can access the money owed to your business within 24 hours of raising an invoice. With the increased liquidity, you can pay your suppliers, negotiate early payment discounts, and quickly reinvest in your business to fuel expansion.
How Does it Improve Cash Flow?
Debt Factoring improves working capital by bridging the cash flow gap between raising an invoice and receiving payment. Accounts receivable is often one of the most significant assets a company owns.
The average Australian business that employs three or more staff is owed over $22,000 by its customers. With the impact of COVID-19, the average time taken to receive payment has increased significantly.
Even before the pandemic, 50% of Australian companies reported that 4 in 10 invoices were being paid late.
For businesses without alternative funding sources, the business owner will have to use their personal savings to bridge cash flow gaps and support working capital. If you don’t have the money to hand, your business can’t take on more orders, and growth stagnates.
Debt Factoring helps to increase liquidity by releasing the capital that is tied up in unpaid invoices. You can access up to 95% of the value of your invoice within 24 hours, rather than waiting 30+ days.
You can overcome extended payment terms and late-paying customers and access the working capital you need to sustain your business growth.
The Ongoing Need for Working Capital
Managing working capital is one of the biggest challenges business owners face. A successful business needs consistent access to working capital to sustain growth.
While a traditional business loan can provide a one-off cash injection, it isn’t flexible to a growing business’s needs. As you process more orders and expand, you need access to more working capital.
Debt Factoring is much more flexible. It works similarly to a line of credit. As you make more sales and raise more invoices, the line of credit increases.
For example, if you raise invoices for $200,000 in April, you could immediately access up to $195,000 using Debt Factoring. With access to capital, you can reinvest in revenue-generating areas of your business, take on more orders, and increase your sales invoice value to $250,000 in May. Factoring your invoices in May will allow you to access up to $242,500 upfront to use in the next month.
With your working capital increasing in line with your sales invoices, you can confidently reinvest in your business and accelerate growth.
Other Advantages of Debt Factoring
Alongside improved cash flow management, Debt Factoring offers several other advantages, including:
Protection Against Bad Debts
Many factoring companies provide Bad Debt Protection as an extra service you can use to protect your cash flow from customers who cannot pay. Additionally, the finance company will only factor invoices for your creditworthy customers. This can help you to avoid overextending with customers that pose a risk of non-payment.
In a factoring arrangement, the finance company will be responsible for managing your accounts receivable and collecting your customers’ payments. Instead of hiring a new staff member or setting up a collections department, the factoring company will handle these tasks for you.
The stress of chasing late payments and struggling to manage cash flow can be damaging to your mental health. Around 75% of Australian business owners have suffered serious mental trauma due to cash flow issues and having to chase payments from their customers.
With a debt financing solution, you can be confident planning your next steps, safe in the knowledge that you will be able to access the money you have already earned.
Designed for Small Business
Debt Factoring is a funding solution that is designed for the needs of small businesses. It’s much more accessible and flexible than traditional small business funding options. You can arrange a funding solution in as little as 24 hours, and there’s no need to use your home as security.
When is Factoring Not Suitable?
While Debt Factoring is a flexible form of funding that can be tailored to your business’s needs, there are some situations where it may not be suitable.
For example, if your business processes most customer payments through cash or credit cards, you may benefit more from a merchant cash advance or Asset Finance. Debt Factoring works best for companies that raise invoices for their goods and services and offer their customers net payment terms.
Because the finance company uses your customers’ creditworthiness to determine the risk involved before funding an invoice, Debt Factoring is only suitable for businesses that sell to customers with good credit ratings.
If you have customers with poor credit or who consistently fail to pay invoices on time, the finance company may offer Selective Invoice Finance as an alternative solution.
How Much Does Factoring Your Accounts Receivable Cost?
Debt Factoring is a highly flexible funding solution, and costs can vary according to the terms of the agreement. There’s a misconception that accounts receivable financing is expensive, but actual costs are usually similar to traditional bank funding solutions.
Factoring fees are usually calculated as a percentage of the total invoice value. The more risk involved for the finance company, the higher the factoring fee. The finance company will look at your sales volume, your customer’s creditworthiness, and other areas of your business to determine a factoring rate.
If need some help deciding if accounts receivable factoring is right for your business, read our post Is Invoice Factoring Worth It?.
Debt Factoring with ScotPac
We provide a range of flexible business finance solutions to help business owners unlock the hidden value in their company. You can receive a tailored Debt Factoring quote and get money in your bank in as little as 24 hours.
Our solutions can act as a primary source of funding or sit alongside your existing funding arrangements. Because our solutions are considered off-balance-sheet financing, they won’t impact your ability to secure more traditional financing at a later date.
Fill out a straightforward online application form or give us a call, and we’ll help you understand your options and create a tailored funding solution for your business.