No Risk, Same Day Business Loan, Immediate Cash, We Take the Risk, blah, blah, blah.
“Approval in as little as 4 hours,” “Same day business loan funding,” and “Fast business loan up to $750K.” Sounds great, right? They can call it a lot of things, but it’s known as Factoring, It’s selling your open invoices to a third party (the “factor”) for immediate cash, and while it sounds like a neat magic trick, it’s not. Remember, successful magic relies on misdirection.
In this case, it’s focusing on solving your problem quickly, not on the negative impact on your business. Factoring is NOT a business loan, and while it can loosen the knots in your cash flow, it might also weave some tricky new ones. Let’s break it down, see what it really entails, and explore some potentially better alternatives.
Factoring can be convenient — it’s quick, it doesn’t need collateral, and you’re technically not borrowing but simply getting your own money faster.
Reality: Factoring services aren’t charity. In fact, they’re predatory lenders, much like payday loan companies. Here’s how they work:
They charge big fees, typically a whopping 5% of the invoice amount or more. On a $10,000 invoice, you could pay $500 to speed up your payment. Alright, maybe that doesn’t sound so bad, but… when you annualize that, it’s an effective 60% interest rate….
Not to mention, if you’re running a business with a tight margin, 5% of revenue can be the difference between a profitable and unprofitable business. Pull you last year’s financials and subtract 5% of your annual revenue from your net income. I’m guessing you won’t love the resulting shrinking profitability or loss creation.
The future cash flow crunch is coming. Sure, it helped to get that $5K in the door today, but you just got rid of the invoice to pay $5K of next month’s bills. It becomes like a carousel you can never get off.
Your Reputation At Risk
If you go this route, you’re turning your customer over to a money lender who is going to take over the collection process, which means the company reaches out to your clients to change the payment address to them, not you. Imagine a client getting a collection call from someone they have never met who only cares about collecting their money. If I’m that client, I now know your business is in trouble. That doesn’t make me feel warm and fuzzy about continuing to do business with you.
The Fine Print
If your client fails to pay, you might have to cover the cost, depending on your agreement. This is known as recourse factoring, which often has higher fees. It’s a case of “damned if you do, damned if you don’t.” Who makes up these s@%$y terms?
So now that we’ve established Factoring sucks, let’s look elsewhere because your cashflow problem did not magically disappear.
Early Payment Discounts: Offer your clients a small discount if they pay their invoices ahead of schedule. It may cost you a bit, but it could prove cheaper than the fees associated with factoring. A 2% discount to pay your invoice “Net 10” (meaning in 10 days) is much cheaper than factoring and keeps your reputation sound!
Negotiating Terms with Vendors: If you’re struggling with cash flow, start by talking to your own vendors. You’d be surprised how often they’re willing to negotiate payment terms. Extending your payment schedule can free up cash in the short term.
Review Your Expenses: Are there any initiatives or investments you can push off in a month or so? Any subscriptions you’re not using that you should cancel? Software contracts you can negotiate down to a smaller number of users? When you’re in a cash flow crunch, it’s the most stressful time to look at your financials over and over again, but it’s necessary to get things headed in the right direction!
Business Line of Credit (a real one): A business line of credit allows you to borrow up to a certain limit and pay interest only on the portion of money that you borrowed. It can be a great way to bridge short-term cash flow gaps, and many banks can get them in place in 45-60 days. (I think I’d like to insert a plug here for an EO Philly business called MultiFunding that helps business owners figure out the right loans for their business)
Sales Push: Give your salesperson/team an incentive to close a few deals quickly. The extra bonuses are a much better solution than factoring fees!
And remember, cash flow challenges are common and can also be symptomatic of larger operational issues. While short-term fixes are necessary sometimes, it’s essential to consider long-term strategies for growth and stability. So, explore your options, weigh the pros and cons, and make an informed decision that fits your business’s unique needs.
If nothing else, if you were surprised by the cash flow crunch, something’s not working well. Just one more reason to stay on top of the accounting and financials for your company because when problems come up, they’re never pretty.
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