Three Powerful Tools To Ensure Good Cash Flow Into Your Business

Cash flow problems are often cited as the number one reason for business failure, and so ensuring that your businesses cash flow runs as smoothly as possible is key to running any business large or small. But what are the options for improving cash flow, and are there any tools that can be used to achieve good long term cash flow?

For any business providing products or services to other businesses on credit e.g. not cash sales, factoring can be a powerful tool for improving cash flow.??Through the factoring of its sales ledger a business is in essence selling its invoices to a third party, the factor. In return for which the factor will make available a pre agreed percentage of the total value of the invoice, before it is due for payment by the customer, with the balance to follow once the customer has paid in full.

A factor will usually handle day to day maintenance of the business’ sales ledger, in effect providing an outsourced sales ledger administrative function. Factoring is akin to a floating overdraft the limit of which is based on the amount of business a business is doing, in addition to outsourced sales ledger processing.??The percentage of each invoice to be advanced varies on the factor, the business in question and the agreement they have, but will usually be up to 85% of the value of the invoice.

Each invoice is raised, will contain payment instructions giving the factor&s details, and a copy of the invoice will also be provided to the factor themselves. The agreed percentage of the invoice will then be provided by the factor, usually within 24 hours of issue, and approval of the invoice.

The factor will then manage collection of the payment from the customer, operating credit control procedures, issuing statements, and dependant on the type of agreement, dealing with any bad debtors.

Once an invoice is paid in full by the debtor, the factor will forward the balance of the invoice to the business, with an agreed fee being paid to the factor. In addition most factors will usually charge “discount charges”. To continue the analogy above these are in effect the interest charges on the overdraft, and will be based on a few percentage points over base rate, calculated on outstanding funds used on a daily basis.

Non-recourse agreements mean the factor will have liability for any non payment by customers, leaving the business less exposed to bad debts. However a non-recourse agreement will not cover cases where a valid dispute over an invoice exists, and will mean you relinquish all rights to deal with bad debtors, including the right to take legal action.

Recourse agreements are often cheaper and accessible to businesses without significant systems, resources and processes, and allow for the factor to reclaim funds advanced on any unpaid invoices. The terms with the factor will make provision for this, stating an agreed time period after payment was due from the client for recourse to come into effect.

Factorings potential impact on cash flow is obvious, in addition factoring can also provide a number of additional benefits to a business:

• Outsourcing of the sales ledger can be a good idea for some businesses anyway, and factoring provides this function in addition to its other benefits, providing improved customer vetting, financial monitoring and reporting, as well as reducing administration.
• It cannot be ignored that if you deal mainly with small businesses they may prefer to deal directly with the business, however having a third party involved can improve debtor payment simply because the factor is taken more seriously. Remember though the way in which a factor deals with your customers will directly reflect on their opinion of your business, good, or bad.
• A good factor can also be a powerful strategic ally, opening doors to new opportunities and potential clients, as well as providing credibility with third parties such as banks, and financiers.??Factoring is not a cure-all for fundamental inefficiencies in a business’ sales process.

If a business receives a large amount of disputes on its sales ledger then these will ultimately need to be referred back the factor, and make the whole process less efficient, ultimately leading to a loss of confidence by the factor in your business.

Some factors may also try to impose restrictions on the types of customers a business takes on, either through dictating specific criteria for customers and/or a certain percentage of business from different profiles of customers, or by imposing punitive charges on certain businesses that may be perceived as higher risk, and therefore making dealing with those customers less attractive.

Many factors specialise in handling specific types of business, for example startups, or exporters, however businesses that benefit most from factoring will tend to fit some or all of the following criteria:

• The business is not reliant on a single customer for 25-30% of its turnover
• Business is spread across a number of customers, but does not involve the processing of large volumes of low value invoices
• The business has customers who adhere to industry standard payment terms and/or are likely to dispute invoices.
• All agreements with customers are a simple as possible, preferably using standardised terms, and do not involve provision for extensive warranties.

For well established businesses, with a proven track record, invoice discounting may be available. Invoice discounting will generally work on a much larger scale and involves the part financing of the total value of invoices issued in bulk.

Under invoice discounting the business retains full control over its sales ledger but provides the discount finance provider with aggregated data of its customers, invoices issued and payments received, and is in effect an overdraft secured on the total value of invoices issued.

Startups and small businesses can do a form of invoice discounting in house by offering debtors a discount on the value of an invoice if they pay within a prescribed period. For example on an invoice with 30 days terms, a discount may be offered if the customer pays within 7 days of the date of issue.

The later form of invoice discounting may also have an impact on the value added tax liabilities of your business, for example under UK law the amount of VAT on the invoice is calculated on the discounted amount not on the total value of the invoice.

For example if you offer a 25% discount for payment within 7 days then the amount of VAT payable is calculated on 75% of the total invoice value regardless of whether the customer takes advantage of the discount or not.

Supplier financing is another form of alternative financing for businesses, sometimes referred to as reverse factoring or supply chain finance. Often used in manufacturing supply chain finance involves a business (usually a large business) providing its suppliers with low cost finance as part of a flexible settlement system.

The factoring market is serviced by a wide range of providers, some are subsidiaries of the big banks, some are specialists in specific areas. A business debt help factoring broker may be able to advise you on which type of factor may be best for your business, but remember all the points above when making a decision.

Factoring is best seen as a long term commitment and will probably involve considerable effort to implement if it is going to be effective, and as such it is advisable not to make decisions based on cost alone, and as with any such process get good legal advice.

Author Byline:

Jacqui Boughton writes for Business Debt Help the UK&s No1 website dedicated to providing debt advice to UK businesses.