Factoring used to hold a difficult position in the finance market because it was associated with companies with poor cash flow and difficult trading conditions, but when used well it is something that can make the best companies better, more reactive and adaptable.
Small and medium-sized enterprises (SMEs) often face challenges when seeking capital from traditional lenders to support their growth and operations and some companies carry a stigma from using these forms of finance which further holds them back unnecessarily.
Two viable options for SMEs to consider are invoice factoring and asset-based lending. In this article, we will explore the circumstances under which SMEs can appropriately leverage these financing methods to their advantage.
Managing Cash Flow: One of the primary reasons SMEs opt for invoice factoring is to address cash flow constraints. These are often seen when businesses experience extended payment cycles frequently and they can be predicted. The use of Invoice Factoring can provide immediate capital. By selling their accounts receivable to a factoring company, SMEs can unlock a portion of their outstanding invoices' value and bridge the gap between invoicing and actual receipt of funds.
Expediting Business Growth: An SME is often constrained by cash flow limitations and want to rapidly expand, find new markets or release new products and they simply cannot fund these new market situations and require rapid access to funds to seize opportunities.
Seasonal or Cyclical Businesses: Construction companies and farming related businesses are example industries characterized by seasonal or cyclical fluctuations in demand and revenue. For these businesses, invoice factoring and asset-based lending can serve as flexible financing solutions. Seasonal businesses often experience uneven cash flow throughout the year, and invoice factoring can help mitigate the impact by providing immediate cash against outstanding invoices during slower periods. Asset-based lending can also be tailored to accommodate seasonal fluctuations, allowing businesses to draw on their assets when needed and reduce borrowing during off-peak seasons.
Credit Limitations or Challenges: SMEs with limited access to traditional bank loans or lines of credit, due to factors such as a short operating history, low credit scores, or lack of collateral, can turn to invoice factoring and asset-based lending as viable alternatives. Often the companies that stereotype this product, but also the companies that often get the least benefit from it as they tend to be maintaining a poor status quo on profitability as opposed to growing the business. Factoring companies typically base their decisions on the creditworthiness of the SME's customers rather than the SME itself. Similarly, asset-based lending focuses more on the value of the collateral than the borrower's creditworthiness. Therefore, these financing options provide opportunities for SMEs to access funding that might not be available through traditional channels.
As a conclusion to the business reasons above – it is also important to note the companies that are drawn to the services often fit into two categories.
Firstly are the traditional users who have cash-flow limitations and have customers that have challenging payment cycles resulting in gaps in their income and so have perpetual low credit scores and lack capital. The products is helpful to these companies to keep them in the market places and maintain the status quo stopping them retracting, but it seems a poor solution in most cases and clever use of alternative financial solutions might be preferable and so financial advice should be sought before concluding on this solution.
Where as, the area when this product really falls into its own is when the customer falls into this category of a profitable company using the product to drive money into the business faster and increasing the payment security while covering the cost of the product in the purchase cost of the associated products. By leveraging their accounts receivable or tangible assets, SMEs can access the capital they need to thrive and navigate the complexities of business finance.
What should an SME do to ensure that it has a positive experience of each of those funding methods?
This is a question that needs to be asked before the service is associated with the business products and used.
It is crucial for SMEs to carefully evaluate the costs, terms, and potential impact on customer relationships before engaging in either option. Consulting with financial advisors or asset finance experts can help SMEs make informed decisions and maximize the benefits of invoice factoring or asset-based lending tailored to their specific circumstances.
If you're considering invoice finance for your business, contact us today and we can explore the options and potential effects of the various ways it can be setup and the effects, and how we can help your business.
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