The traditional definition of an entrepreneur is one who shifts resources from a lesser optimal use to a more optimal use, hence shuffling paper to create more money.
Today I want to discuss how exactly you can do that to accelerate the cash flow in your business, mostly through a concept referred to as accounts receivable factoring.
Simply put, it is the practice of selling off funds owed to you by someone else in order to collect the cash today rather than waiting for when you are actually owed the funds.
The easiest way to explain this concept is in terms of a service providing business. Say you own a service business and you provided $10,000 worth of services to Client A. You subsequently billed Client A $10,000 payable in 30 days.
Instead of waiting 30 days to collect, you may decide to sell the receivable (amount owed to you by Client A) to an accounts receivable factoring company (also called a “Factor”) so that you receive the cash today.
The Factor may pay you $9,990 today, and will later collect the full $10,000 from your Client A in 30 days when the payment is due. As you can see, there is a small fee involved in factoring called the discount rate or the factoring fee.
There are many reasons why a business may decide to factor receivables, mainly to expedite the receipt of cash flow for use in its working capital or growth capital as the business expands.
I leveraged this concept in my dry cleaning business. My business has contracts with several large vendors, including government entities. These vendors are typically used to payment terms anywhere from 30 to 60 or more days.
Instead of waiting the full duration, I don’t mind factoring the receivables and collecting the cash today. Another benefit of doing so is that I am putting the onus of collection on the Factor company. Moreover, I no longer bear the risk of my customers defaulting or not paying me. You can check out the Accounts Receivable Factoring Guide to learn more about this topic.
Although the example above appears quite specific, this concept has much broader implications. For example, if you win the lottery, you wouldn’t be reading my blog! Na – if you win the lottery, you are given the option to collect a lump sum today or installments over the course of months and years.
If you select the earlier option, you will receive a much smaller amount than you would cumulatively over the years. The difference is equivalent to the discount factor or fee / commission that I referred to above.
Another common application of factoring is in structured settlement cases. A structured settlement is an agreement to pay / collect over the course of weeks, months or years often resulting from a lawsuit or injury claim of some sort.
A structured settlement is awarded to the claimant (for example: you) by the judge / courts. When you have been awarded a structured settlement, you have the option of factoring it, or selling it in the secondary market so that you can accelerate the cash flow you can collect today?
Why might you be interested in cashing in today despite collecting a smaller amount relative to what you would collect over the life of the settlement? Let’s see. You may want to start a business and need seed capital? Or you might want to pay off your mortgage or other sizable debt.
You might want to fund your child’s or grand child’s education, or feel you can grow your money faster and larger by investing on your own. There are many other reasons why you might consider taking a lump sum today rather than collecting over time. You can check out the Structured Settlement Guide to learn more about this topic.
In conclusion, I will say that there is a lot more to these topics, such as recourse and non-recourse accounts receivable factoring agreements, buying and selling structured settlements in the secondary market, legal and regulatory implications, etc. but I will stay away from those at this point.
I realize that the bulk of my blog’s readership is interested in blogging and internet marketing related topics. And while I can certainly get into the details of accounts receivable factoring and structured settlements, I realize that these topics apply to only to a small percentage of my blog’s readership.
That said, I wanted to cover these concepts at a high level so that you are aware of them and can leverage them if and when they become applicable to you. They say knowledge is power, and I hope I have shared some of it today with you.
Can you see an application of this concept for your business today or in the future?