According to a recent Inc.com article, 96 percent of U.S. businesses fail within the first ten years. That’s a staggering figure, even during the worst of times. But the primary reason for this high rate of failure has nothing to do with the overall economy. In most cases, the problem is a lack of cash flow.
According to financial blogger Michael Lewis, “Owners who cannot efficiently manage their cash flow are almost certain to fail.” But for startup companies, this can be a real challenge. Income and expenses can fluctuate greatly during the formative years of a new business, and most entrepreneurs simply don’t have the time or the inclination to effectively manage their collections activities. Far too often, minor shortfalls quickly snowball into major cash flow issues.
Cash Flow Solutions
For established companies with a strong credit history the solution is frequently to secure a loan or line of credit from bank; however, traditional lenders are usually reluctant to lend to startups who typically don’t meet their stringent lending criteria which can include time consuming audits and collateral requirements.
Instead, many small business owners turn to alternative funding sources. These can include loans from friends and family members, angel investors, venture capitalists and even high-interest cash advances on their personal credit cards. The basic problem with each of these solutions is that the cash flow relief they offer is ultimately negated in the form of increased debt for the business owner.
Over the last decade, another solution known as factoring has made a resurgence and has become a popular financing option among startups and even some established businesses. In fact, some banks have even gotten in the game, offering factoring programs of their own.
How Factoring Works
Factoring is a quick and simple process that provides immediate cash flow to your business. Here’s how it works. The business owner sells her accounts receivable to the factoring company at a discounted rate – typically 90% of the actual value. Factoring funds are often paid to the business owner within one to two days, providing them the immediate working capital they need to meet payroll, acquire new equipment or inventory, or take vendor discounts.
The factoring company handles the accounts receivable collections process and pays the business owner the remaining 10% of the invoice, minus the invoice factoring fees.
Unlike traditional bank loans, factoring does not require a financial audit of your business, and some factoring companies do not charge an application fee.
According to Jack Stieber, President of Dallas-based American Receivable Corp., “Another benefit of factoring is that it does not increase your debt position. In fact, factoring can actually improve the credit rating of your business, and this can be very beneficial to startup companies.”
Factoring requires no long-term contract, and Stieber says many of his clients return to traditional lenders once the factoring agreement is completed. However, factoring is such a time and cost saver, that a large number have become long-term customers who regularly factor their accounts receivable.
Plan for the Best – Prepare for the Worst
Effective budgeting and cash flow management are essential to the life of any business. Whether it’s a line of credit, personal assets, venture capital or factoring, experts agree that having a contingency funding plan in place is a good way to safeguard against unexpected events and economic downturns in the marketplace.
Anne Capps is Senior Vice President of Green Bank N.A., a nationally-chartered commercial bank headquartered in Houston, Texas.