Invoice factoring: Is it right for your company?

US-PDGov

By Floyd Davis

This article is going to show how a business can basically wash its hands of the messy and costly task of managing accounts receivable. For large businesses, the accounts receivable (AR) department is a large unit of the company employing teams of accountants and clerical workers. They work to keep straight all that has to do with invoicing the clients and keeping track of the payments they make.  They may even run a call center, manage the customer service portion of the company's website, and otherwise provide customer service to vendors who owe money.

This guide will show why this entire AR department can be outsourced, and how this will result in faster cash inflow for the business. If there had to be a one sentence summary of what  invoice factoring is, it would be:

Outsource your accounts receivable to a third party company who will pay you a portion to up front for the invoices for a fee.

Invoice factoring as a way to raise capital for business expansion is not a new business technique, but it's often overlooked. Now, with credit more difficult to obtain, small businesses are investigating invoice factoring as a way to quickly and easily raise cash for working capital requirements.

Approval for bank loans for small businesses is difficult to come by, as loan requirements get stiffer and stiffer in the post- credit crisis world. Bank loans also require application fees, lengthy application procedures, and lots of paperwork and preparation. And don't forget the interest on a bank loan.

Invoice factoring is better than a loan

Invoice factoring compares favorably to a small business loan from a bank in all these aspects, which is why it's a fast-growing segment of the business world.

Incurring debt with a small business loan is not always a sound option. There's risk involved with any type of loan. Unfortunately, it's just how business is done if expansion is in the works.  Few small businesses have extra cash on hand for major improvements or expansion. Taking on a loan is common.

Invoice factoring, on the other hand, involves no long term commitment, no chance of defaulting since it's not a loan, and no up front fees commonly associated with a bank loan. The business simply sells its invoices, receives cash for them, and the transaction is finished. The downside is that only a percentage of each total invoice is received. The rest goes to the invoice factoring company, which is the only fee the business pays. Having cash on hand quickly and removing the uncertainty of unpaid accounts receivable are the rewards of working with an invoice factoring company.

Freight bill funding

If you are a transportation company with a cash flow problem then freight bill funding might be of interest. It's jut like invoice factoring but it's for the transportation industry. One big difference is that with freight bill funding, clients can receive their funding in the form of a fuel card.  The fuel cards can then be used by the truckers in the company like ATM cards.

Fuel cards are accepted all over the country at thousands of locations, just like ATM cards. Fuel is a company expense, so having truckers use the fuel cards which are funded by freight bill funding is very convenient for the transportation company that uses the service. Trucking companies need constant cash flow because of their fuel charges, so using the Fuel Cards puts cash in the hands of the people who need it.

Floyd Davis is a blogger for the finance industry and more of his articles can be seen at irsrefund.biz

How to keep cash flowing into your business

By Gerwyn Wallto 

Keeping cash flowing into your business is essential for ensuring the success of your financial endeavor. What you will need is a management system that will allow you to keep track of all the inputs and outputs of your business, so that you will never run out of money. An online cash flow management system is the best recommendation because it can keep an eye on all your business financial aspects, without having you experience as little as a headache. Here are some of the things that online cash flow systems can help you with. 

Accurate calculations 

It is often said that if you fail to plan, you plan to fail. The same thing is valid when it comes to cash flow management. You will need to know exactly how much money is coming in, and how much of it is going out, as well as the durations of time that pass between inputs and outputs. An online cash flow management system can keep track of all these aspects for you, and in a very accurate way, so you will never have to worry that you have forgotten about a certain pay-in or pay-out and mess up your entire financial schedule.

 Keeping track of good paying customers

Online cash flow systems can serve you in many ways. For instance, a good online cash flow management will be able to keep track of good paying customers and you will be able to reward them with a small discount, for instance, in order to make sure that you keep them as your clients. Also, reliable online cash flow software will allow you to differentiate between good clients and customers that often delay payments. In the later case, you can insist that they pay on delivery, so that your cash flow is not affected.

Watching out on your expenses

With online cash flow management, you will be the one in charge of all the expenses. You can schedule their payment in a way that allows cash to flow into your business continuously. For instance, you can program the payments to be done automatically just before their due date, to make sure that you have access to liquid cash for as long as possible. For businesses, such an advantage is not to be taken lightly. Online cash flow management offers you the means to monitor all your expenses and payments all the time, and also the means to choose the best solutions for your business.

Understanding the accounting concept of cash flow

The accounting concept of cash flow provides insight into businesses operations and cash positioning at the time the cash flow is recorded. Cash flow in its simplest form is the sum of cash that moves in and out of a business, specifically in terms of business operations, financing i.e. borrowing activities and investing activities. These three elements of cash flow are frequently recorded on the cash flow statement. (investopedia.com)

Cash flow statements, which became mandatory financial reporting statements in 1987 (ibid) illustrate cash details not included in other financial documentation. Since net income includes revenue owed but not received, this net income calculation can fall short in accurately reporting a companies complete financial position. (Brigham and Houston p.48) For example, net cashflow subtracts depreciation, amortization and cash receivables that haven't been received from net income (Ibid)

Why cash flow is important

Cashflow is important because it provides financial analysts, managers, shareholders and regulatory institutions such as the Securities and Exchange Commission (SEC) or the Federal Deposit Insurance Corporation (FDIC) with more detailed information regarding a businesses cash inflow and outflows. This information is useful in determining several factors regarding a business or company's use of cash. A few of the insights and facts revealed by a cash flow statement include the following:

• Demonstrates efficiency of cash utilization

• Allows for more comprehensive financial reporting and identification of cash usage

• Cash flow returns over time i.e. with several cash flow statements

• Operating, financing and investing activities

• Information used in calculating cash flow ratios and equations ex-net cash flow

• Assists in determining business valuation *Allows for more comprehensive financial reporting

How cash flow is measured 

Cashflow and information within cashflow statements is used in measuring several useful accounting and financial functions. Three such metrics include 1) net cash flow calculation 2) cash flow ratios and 3) cash flow based calculations such as present value of cash flows and internal rate of return. (wikipedia) Since the cashflow statement is divided into three sections included cash flow from operations, investing and financial activity, different ratios can be formed using each area of the cash flow statement. For example, the operating cash flow ratio is determined by dividing operating cash flow by current liabilities. (Brigham and Houston p.56) A few of the different cash flow ratio metrics are listed below.

• Operating cash flow ratio

• Price to cash flow ratio

• Free cash flow ratio

• Cash flow to debt ratio

• Working cash flow ratio

Additional cash flow measurements such as present value of future cash flow and internal rate of return use cash flow values to determine how much a series of cash flows are worth in terms of achievable interest rates as applied to each cash flow over time in the case of present value of cash flow (Brigham and Houston p.294) and matching costs to present value through adjustment of interest rate in the case of internal rate of return or IRR. (Ibid. p.509). These latter two calculations are quite important in bond and project valuation because they allow investors and managers to determine reasonable assessment of valuation and worth.

Both present value of future cash flows and internal rate of return can be calculated by using the functions of a financial calculator. For example, if a business has a 12 annual cash flows of $100, that are able to earn an interest rate of 10% upon receipt and where the first payment is received at the beginning of the first year the following function buttons can be used. N (Number of payments), I (Interest rate), PMT (Payments/Future cash flow), and FV (Future value). (Brigham and Houston p.295). 

To calculate the present value of future cash flows first determine the future value for poseterity by entering the values using these function buttons. For example, N=12, I=10, PMT=-100, PV=0 then CPT (compute) FV=$2138.428. Since payments are reversed the value is recorded as negative. Then, to compute the present value of the future cash flows, enter the same values except enter $0 FV and compute PV for a value of $681.369. (Ibid.p305) This is also called an annuity cash flow present value.

Summary 

Cash flow is a vital part of business operations and is often reported on the 'cash flow statement'. Cash flow is the movement of cash in and out of a company for various purposes over a given time and as recorded in the cash flow statement. Cash flow records can be used for a variety of financial and accounting purposes including valuation, assessing business management decisions, determining cash solvency via cash flow ratios, and illustrating how and where cash is used in a company. The cash flow within a company is a dynamic and important aspect of business operations, financing and investment for which the ideal balance of cash usage varies depending on type of business, economic conditions, business management and accounting reporting requirements.

Sources:

1. Eugene F. Brigham and Joel F. Houston. '0Fundamentals of Financial Management 9th edition'. Mason, Ohio. Southwestern, 2001. P.48-52.

2.http://www.answers.com/topic/cash-flow-statement 

3. http://www.investopedia.com/articles/04/033104.asp 

4. http://en.wikipedia.org/wiki/Cash_flow 

5.http://www.exinfm.com/board/cash_flow_ratios.htm 

6. http://www.candlestickforum.com/PPF/Parameters/11_1262_/candlestick.asp

How small-business owners can effectively manage cash flow

Managing business cash flow affects business functionality and profitability because cash flow is the use of and movement of cash in and out of a business. Too much cash in one aspect of a business can adversely affect another aspect of a business and the inverse relation holds true as well i.e. too little cash in operations can lead to costly debt and lower net gains after return on investment.

Cash flow management can be tackled by dealing with several parts of the business by optimizing the cash flow for profitability in each of those parts. For example, business loans refinanced at lower rates optimize outflow by reducing interest costs. The goal of cash flow analysis is ideally to allow adequate availability of cash for business activities, in addition to helping maximize profit margin and/or net income after costs, taxes, depreciation, expenses and dividends if any.

The three major areas on the cash flow statement include operating, investing and financing activities. Small business cash flow always has operating cash flow and may have some form of investing and financing activities, but the amount of the latter two depend on the size the business.

• Operating cash flow

Operating cash flow should generally be positive due to steady or increasing accounts receivables, net income, and depreciation expensing of property. Cash flow notes may also increase the final operating cash flow number however an increase in operating cash flow because of liabilities may not always be a good thing.

• Cash flow from investing

A second area of cash flow is investing. This aspect of cash flow should generally be negative as cash not invested via capital expenditure in fixed assets or investments in equity ownership is cash that is potentially not growing as much as it could. Investing cash flow may also vary depending on the economic, and business cycles, in which case the cash flow may be strategically lower.

• Financing cash flow

If a company makes use of equity and/or cash flow loans, cash flow can be negative or positive depending on whether shares have been sold or debt paid off. Generally, the business development plans will determine if a business needs to pay off or expand its financing in a given fiscal quarter or year. For example, for companies seeking to expand and develop new projects the cash flow may be positive through debt or equity financing. However, if a new project has been completed and is now returning a profit, it may be a good time to pay off some or all of the financing for it.

• Tips for improving cash flow

Asset management can aid in lowering interest payments, accounting for maximum tax benefits and obtaining cheap or affordable financing. Lowering credit costs, reliance on lines of credit, and write offs benefits cash flow. Inversely, increasing accounts receivable terms and penalties may serve a similar affect. Risk management incorporates cash flow need forecasts in business down times, seasonal and economic cycles helping the business run smoothly. Keeping an eye on costs, business credibility, liquidity and profitability ratios can assist in the cash flow analysis process.

Cash flow management is an continuing process that is either subject to the scrutiny of private, public or individual ownership. Regardless of who owns a company, the goal of business functionality and profitability is facilitated by effective cash flow management. Through an optimization of the operating, financing and investing activities in addition to keen asset, and risk management, the cash flow of a business can not only assist with annual goals but may also aid in demonstrating management expertise to any potential investors, vendors, venture capitalists or banks.