Sales on credit are a common feature of the business world nowadays. Because so many businesses now offer this service to their customers, smaller businesses have to offer it as well. If they don’t, they will be unable to maintain a profitable position in the industry. To maintain and expand market share in any industry, business owners have to factor in the risk of credit sales. On the balance sheet, all credit sales show up as an asset in the Accounts Receivables/Debtors Account.
However, any man with a rudimentary knowledge of accounting can determine that these assets mean little. A company that generates income from its debtors does not make any money until the debtors pay. This can take anywhere between a month and up to a year. Businesses usually create provisions in case customers are unable to pay. This delay in receiving payments can be harmful to a smaller business entity. Smaller entities rely heavily on their cash sales to fund their Working Capital Account, and a lack of cash flow can severely limit business activities.
That is why factoring receivables is an excellent idea for such businesses. Factoring receivables, or discounting receivables, is a type of asset financing in which a company factors, or leverages the amounts in its receivables account. In return, the factoring company makes a payment up to a certain percentage of the total amount factored. There are many benefits of factoring receivables. Here are a few:
1. Instant Injection of Cash
The obvious advantage of factoring receivables is the instant influx of cash that a business can immediately use. The delay in receiving cash payments from debtors can seriously hinder business activities. However, by factoring receivables, companies no longer have to worry about debtor payments. Instead, they can focus on expanding their business as their working capital is replenished. Rather than constantly chase debtors and send them payment reminders, businesses can transfer the risk to a factoring company and get a slightly reduced amount within a few days.
2. Flexible Financing Limits
Asset type financing, such as factoring receivables, have very flexible financing limits. Some companies offer financing from a minimum of $25,000 and go as high as $4,000,000 per month. This is great for startup businesses that are going through a phase of expansion. Factoring receivables allows them to instantly convert their debtors balance in to a cash inflow.
3. It Is Not a Debt
Taking out debt can be a lot of hassle. A lot of paperwork is involved, and the debt also shows up on the balance sheet. However, financing by factoring receivables does not show up on the balance sheet as debt. Companies simply increase their working capital and reduce their Accounts Receivable/ Debtors’ Account.
