Where does a small business turn when the banks turn them away? This is becoming more and more common in late years as the banks feel the pinch in their own coffers, having lent out millions in bad loans and irretrievable credit due to business going insolvent.
There are many hoops a business needs to jump through to be approved by a bank for a small loan, and there are many reasons why a small business would need such a loan. Cash flow is usually the primary candidate for a company's directors visiting a bank, hat-in-hand, asking in no uncertain terms for an increase in their line of credit.
As the banks entrust in their willingness to pass out the cash, businesses must resort to more left-of-center mechanisms to secure a line of credit quickly. Legitimate and ethical factoring companies are one option. The days of the loan sharks are dwindling (depending where you live in the world …) and many legal entities have sprung up in their place, recognizing that it is a market ripe for the plucking.
Companies that get caught out with their cash flow erring on nil, or worse still in the negative typically find themselves in such a position because they've paid their staff, their bills and their rent, but their clients have not returned the favor by paying their invoices on time.
While the need for a short-term cash flow solution is purely a 'trailing indicator' highlighting the problem, which a business should act on (they should make their payment terms less than those of their creditors) it does not change the fact that If a quick injection of cash is not found, the company will have its creditors baying for blood.
Enter the factoring solution. Factoring involves a marginal third party company, which will purchase any invoices owed to you, the floundering business, to a percentage of their value, and give that cash deposit in as little as 24-48 hours. This immediate company will then chase your client for the total invoice. Once that amount has been received, the factoring company pays you the difference less their commission for their service. While this might seem like 'legal loan-sharking' on the surface, it is all done above board, and this impartial factoring company is illegally to touch bad debt seeing as they stand to lose out.
What is important to note if you choose to go down this path is that research is the key. Some factoring companies compound their interest over time until they are paid by your client, and send you the bill. Here's a possible scenario;
· You are owed $ 50,000 by your client, who have intimated they can not pay you for 30 days, but you need that cash in a week due to $ 30,000 in bills and wages you need to pay.
· Enter the factoring company, who buys that $ 50k debt at 80% giving you $ 40,000 in your bank within 24 hours. Great your cash worries are sorted!
· Under the terms of your agreement with said factoring company, you'll be charged 7% in commission for the help, so out of that $ 50k, you're to receive a total of $ 46.5k.
· However, this is calculated monthly, and after 3 months, your client still has not paid their initial debt, now owed to the factoring company.
· This has compounded the interest to 21% (over 3 months, 7% per month) of the total amount, which is $ 10.5k.
· Under this scenario, you've now exhausted the $ 10k buffer you had, and now owe the factoring company $ 500 for their troubles.
The moral? Ask around and make sure you're informed about all the terms and conditions before you engage a third party to help you out of a cash-flow jam.