The answer is simple: A business should sell its accounts receivable to improve their cash flow. The unfortunate truth of every business is that there are going to be periods in which cash flow becomes a problem for a variety of reasons which can contribute to the failure of a business. Poor cash flow does not mean a business does not offer a great service/product or have outstanding profit margins. It just means the business’s cash flow stream is tied to slow-paying or non-paying clients.
Business sometimes offers Net-30 to Net-60 day terms to clients in which they give those clients a window in which they can pay for the product/service that has been delivered. Giving the clients time to pay is beneficial for many reasons, but the fact remains that there is a 30 to 60-day window in which the business is waiting to be paid, sometimes longer. This window in which there is no cash flow from one or more clients puts the business at risk of running out of cash.
By making the decision to sell receivables to a factoring company, the business is making the decision to increase their cash flow. Not only does the cash flow increase, but it increases instantaneously as the factoring company pays upfront. Of course, factoring is not for all businesses, and it is suggested that this process works best if the gross margins are at least 15%.
An alternative for businesses is to attempt to use regular financing options such as a bank business line of credit. However, not all businesses qualify for this option because they do not meet the requirements set forth by banks. Qualifying for a line of credit can also be a lengthy process. Some of the advantages that factoring has over regular financing options include sales growth, a factoring line that adapts to a businesses’ sales, quick decision making, no financial reporting headaches or loan covenants to contend with and no new debt since factoring is nothing more than an asset swap of cash for accounts receivable instead of cash for debt.