Invoice Factoring and Accounts Receivable Financing for Small Business

Small Businesses are still suffering from a lack of available capital for expansion, purchase of new equipment and for just making payroll until a client pays.

First a little background. Factoring, or the act of selling invoices at a discount, is a financial product that has been available since the birth of merchant and customers. There are many factors in the world and many focus on specific industries or even segments within industries. Like Temporary Staffing, Trucking, Software Developers, Coders, Oil and Gas services and more.

Accounts Receivable financing, another name for Factoring, requires a small business owner to sell an invoice for an advance against that invoice. The factor will typically provide an advance of between 70-95% of the face value of the invoice depending on a few things. First, the strength of the Account Debtor or the person that owes the small business money, for a service or product. The Account Debtor is typically another business.

The process for starting to factor is much like obtaining a commercial bank loan or home loan, expect that Factors will work with clients who aren’t bankable or able to secure financing from a traditional community bank, credit union, or national bank. A basic application is completed and information is provided for the underwriting of the invoice and client. These documents will usually include the businesses financials, information on the account debtor, a background check, and documents related to the invoice, contracts, purchase order and more.

Once all the documents are gathered the factor will complete its due diligence and underwrite and quote factoring the invoice. The underwriter will also recommend a term for factoring, since you will be putting your future invoices up for security in the event the invoice doesn’t pay, or some other calamity prevents the payment of the factored invoice.

Factoring can be expensive, and it can also be very reasonable. When comparing the cost of financing, merchant advance loans, credit cards, and other typical small business financing, factoring may actually be a bit cheaper. Again the cost to factor is based on the risk and likelihood the invoice will pay the factor. The cost is also determined by the credit, collateral, character of the small business requesting the factoring.

The easiest way to look at factoring is figuring its cost on a monthly basis. It’s not uncommon for a factor to offer very attractive rates or at least advertise them online .35% to5.55% but the reality is those are 10 day rates or something near that. A typical factor will charge between 1.5% for the highest quality factor to over 5% for risky invoices that have a higher risk profile.

3 Tests To Qualify For A Small Business Loan

Banks and other lenders are really only concerned about one thing; getting repaid.

After all, that is how they still make the bulk of their revenue; making loans and getting repaid both interest and principal.

Thus, to qualify for a business loan, you simply have to demonstrate that your business can service the loan request – meaning being able to make the loan payments for the life of the loan.

Most lenders will perform the following 3 analysis calculations to determine if your business has the cash flow to service the proposed new loan.

1) Spread The Financials:

Banks / lenders will require three years of past financial statements at a minimum. The reason is to see if your business could have serviced the loan over the last three years. If it passes this test, then your business should be able to service the loan for the next three years.

Thus, they use your past business performance to determine what your future performance should be.

To spread your financial, most lenders will do the following for each past period that your business provided financial statements:

  • Take your net income (that is your net profits after all operating costs, taxes and interest payments).
  • Add back any non-cash accounting items like depreciation (deprecation is not an ongoing cash expenses but an accounting anomaly to reduce taxable income for tax reporting purposes only).
  • Add back any one-time charges or expenses – expenses that are not expected to reoccur in the future.
  • Then subtract out the interest charges for the proposed loan – only the interest portion at this stage as interest payments are considered regular business expenses.

This results in the true net positive (hopefully positive) cash flow of the business – cash flow that will be used to pay the principal portion of the business loan.

Now, if your business’s cash flow at this point can cover the principal portion of the loan, you have almost pasted this test.

Most lenders will not just want to see if your business’s cash flow meets the minimum principal portion of the proposed loan but would like it to cover 25% or even 50% more. The reason is that should your business have a slow period and revenues decline by say 25% or 50% – your business’s cash flow would still be sufficient to make the loan payment.

Example: Your business requests a $100,000 loan for three years with a monthly payment of $3,227 – broken down as interest of $449 and principal of $2,778.

Therefore, your monthly cash flow should not only cover the $2,778 in principal but say 1.25 times more or $3,473.

Also, keep in mind that this cash flow figure should not only cover the proposed loan’s principal but the principal payments of all the business loans the company has.

Principal payments are not income statement items and are not accounted for based on normal operating income and expenses but are balance sheet items and are paid out of net income (after all operating expenses).

Interest charges from loans are an operating expense and accounted for when the financials are spread.

Financials could be spread monthly, quarterly or even annually – depending on the types of financial statements requested or the policies of the lending institution.

If you can past this test via your past business performance, then it is highly expected that your business will do the same in the near future.

2) What If Scenarios:

Here, the lender will perform a series of “what if” scenarios on your financial statements.

For example, they may take your total revenue per period and reduce it by 10% or 20% – keeping all other items (your expenses) the same.

Then, spread those numbers again to see if your business could still service the proposed loan – e.g. still have the cash flow to make the payments.

Again, reassuring the bank or lender that your business would still be able to repay them should your business hit a slow period.

3) Debt-to-Equity Ratio:

Lastly, while your business may be able to service the proposed loan’s payments, banks also want to ensure that your business is not over leveraged – meaning that your business does not have too much debt in comparison to its equity.

Let’s say that the entire market declines or crashes and your revenues fall so low that you are forced to shut down the business. In this situation, would you still be able to repay all your lenders – including this proposed loan?

Thus, lenders look to a safety measure known as the debt-to-equity ratio.

Measuring your debt-to-equity is simply taking your Total Liabilities and dividing them by your company’s total equity.

The higher this ratio, the more risk the business has as it is relying on too much outside debt financing.

A ratio over 3 (meaning that the business has three times the debt as it does equity) is too much risk for most lenders to feel comfortable with.

Most businesses will have a debt-to-equity ratio between 1.5 to 2 and are considered safe to their prospective lender.

Now, if your business does not pass all these tests with flying colors and you still need a small business loan to grow, then it is up to you (the business owner) to manage your company in such a way to bring your business in line with these tests.

It all starts with your understanding of your business and the measures it has to pass to qualify.

Social Media is Right For Small, Medium and Large Business

There have been an explosion of social media sites appearing online recently, and each one can be used to optimize your business in a variety of different ways. What follows are three methods that should be adopted by your business to enable you to harness the full power of social media within your business.

1. Create a Fan Page For Your Business On Facebook.

Facebook is one of the most promising social media sites when it comes to marketing your products. One good way to use Facebook is to create a fan page on the site; and to use it to draw in potential buyers.

Start by investing some time to create a high quality fan page. This page should include links to your site and a well-written description of what you do, and a brief description of the purpose of your fan page. ( i.e. to provide all of your loyal customers with free information about upcoming product launches, give aways and coupons).

If you don’t yet have enough fans to get the ball rolling, it might make sense to start by giving people an incentive to become a fan. You could do something like this: offer everyone who joins your fan page a 20% discount coupon for one of your products. You could then say something like “If this fan page has over 5000 members by September 1st every fan will get a product for free.

2. Think In Terms Of Social Capital.

When it comes to using any form of social media services to promote your business, it is always a good idea to think in terms of building social capital that will generate flows of returns over a long period of time.

It’s important to understand this because many marketers treat social media sites like pay-per-click (PPC) advertising services. That is they expect to see returns immediately after creating an account on Facebook or twitter.

In reality, using social media sites correctly requires that you build up a large following over a long period of time. You can think of these networks that you are building as a form of capital. Once sufficiently large, you can begin to use it to bring in additional members without actively marketing and additional customers.

3. Using The Twitter Search Engine.

Another approach you can take is to use the twitter search engine to find tweets related your business’s niche. This is an easy way to locate people who are interested in your products or services.

Once you have located some tweets related to your niche, you can follow them back to the source, determine whether the person involved might be interested in your niche, and then invite them to follow you if so.

Initially, a lot of people you add may not opt to follow you, however, over time, if you accumulate 50 new followers a day, you’ll gain momentum. If you make interesting tweets, offer discounts, or tweet vital information, you might get re-tweeted, expanding your reach and possibly bringing in new followers.

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