Cash When You Need it Most: How to Use Your Customers Credit to Borrow Money Now

Employees won’t wait for payroll and landlords don’t want to hear about your cash flow when rent is due. Sure, cash is a problem.  But if you have Accounts Receivable, you already have the keys to unlocking more cash. Here’s how you can get the cash when you need it the most:

The Root Cause

The biggest cash problems are caused when we send expensive goods or services to our customers, and then give them 30 days to pay.  Yes, it is just good business to offer your customers a bit of credit… but when 30 days turns into 45, 60 or even 90 days?  Well, now you’re just lending your customers a bunch of money — and if you’ve lent it to them, you don’t have it to use yourself.  Meanwhile payroll is due, the rent is late and baby needs new shoes.

Fine you say, “I’ll call the customer and make him pay!”  Good luck.  The best customers know they have power over you.  If you want their business, you’ll get your payment in 60 days.  No exceptions.  Giant companies like WalMart, GE and the Federal Government are famous for holding up payments.  They always pay their bills … but they always pay their bills late. Calling to rattle their chains is just as likely to make them mad as to make them pay.

Take Collections to Zero

If you’ve followed this blog for long, you probably know that you can calculate the average time it takes to collect an invoice.  The math is easy, so grab your financial statements and do this now: Divide Accounts receivable by Annual Sales.  Now multiply by 365.  The result is the number of days that your customers are using your money. (Read about the cash conversion cycle for more.) The ideal result is ZERO: if your average collection days goes to zero, the money currently in Accounts Receivable will instead be sitting happily in your bank account.

AVERAGE COLLECTION DAYS = (Accounts Receivable / Annual Sales) * 365

If this is any number greater than zero, you have an opportunity to improve your cash flow by collecting faster… or by using your Accounts Receivable to do what is called “Accounts Receivable Financing“.

What is Accounts Receivable Financing?

First, it’s not new.  Its not scary.  And its not terribly expensive when done right. Accounts Receivable Financing is common and includes various ways to borrow against the value locked up in your Accounts Receivable (A/R).

A/R Financing includes factoring and invoice finance (plus “trade payables“, which is an interesting twist on the same concept).

In brief, you allow a bank or finance company to hold and collect your Accounts Receivable in exchange for an upfront payment or loan.  The lender helps you take your Average Collection Days down closer to zero, and charges a small fraction of the invoice value for the service. There are variations: some lenders collect from the client directly, others do not; some will pay you everything up front, others will wait until the client pays before making a final “rebate” payment to you.  Contracts are generally straight forward and with a little practice the process becomes quite simple.

Like most things, A/R financing has even been web-ified.  New websites, like CBAC Funding, are popping up to help business owners find and broker deals between various A/R finance companies.  Using an intermediary makes the whole process easier and safer.  Much like using a mortgage broker, an A/R finance broker can get you several bids from various lenders from a single simple application process.  Other sites, like The Receivables Exchange, help you take a more “Do It Yourself” approach.

But the coolest part of AR Finance is that the credit is not based on your credit, but on the credit of your customers.  You are actually borrowing money by using your customers’ credit!  If you’re doing business with WalMart, GE or the government this is a no-brainer. Smaller customers will qualify too, though the fees or discount rate (equivalent to the interest rate on a loan) will be a bit higher.

Unlock A/R for Better Cash Flow

If you ask a couple of old-timers (like me) about factoring, you’re likely to hear a few horror stories.  AR Finance used to be the wild west of lending.  But today’s finance companies are more professional and more efficient than ever.  Its not the cheapest loan you’ll ever get (many companies keep up to 5% of the invoice value), but it may be the easiest and fastest way to unlock the value of your A/R.

Remember: You are in control.  If you don’t need the money this month, don’t give the lender the invoice.  And if you have customers that are not so credit worthy, you can exclude them from the deal (which can help you get a better rate).

Like all finance deals, get several quotes and read the fine print carefully. An intermediary, broker, website or CFO advisor can help sort the wheat from the chaff.

Dedicated to your (fast-paid) profits, David

3 Comments
  1. As always great perspective David

    TRE is a NYSE traded company leaving behind the factoring horror stories of the past – a Receivable from Walmart will get scooped up in 13 seconds…quite a sight!

    Keep the great info coming!

    • Thanks Craig:
      Receivables Exchange and CBAC Funding are starting to really change the face of invoice finance. Its a good mix of web 2.0, crowdsourcing and old fashioned brokerage. My only surprise in this was that I did not see many other websites doing it.
      Cheers,
      David

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