Slow paying customers can grind a business to a halt. Without cash flowing in, it’s impossible to send cash back out again to continue growing and operating your business—vendors, employees, and the IRS won’t wait to be paid.

If you’re reading this, you’re likely a business owner, CEO, or CFO who’s maybe looked at the balance sheet and thought “I’d be in much better shape if my customers paid on time”. Perhaps you maxed out your line of credit; perhaps you can’t get approved for a line of credit. We hear you, and won’t waste your time disguising a sales pitch. We believe accounts receivable factoring (also known as invoice factoring, or just factoring) can be a powerful solution for businesses with commercial receivables.

Accounts receivable factoring is a financing tool used by businesses whereby they sell their unpaid receivables to a factor in exchange for immediate cash. Often, the factoring company advances 80-90% of the receivable upfront, and releases the rest (minus a fee of 1-6%) once the invoice pays.

AR factoring aligns delivery and collections, so you can focus on growing your business, rather than chasing down payments.

If you’d like to learn more about how factoring can help you solve the problem of slow paying customers (and why this is a problem to begin with), read on. But if you’ve heard enough, and think factoring could solve your problem, reach out to us below:

Understanding the Problem of Slow Paying Customers

Finishing a job seems like it should be the end of the work. The unfortunate reality is quite different for many businesses. Once you finish a job, you could be left waiting 30, 60, or even 90 days to get paid. This could extend to even 120 days depending on your industry and your customers.

Slow payments don’t necessarily mean you have bad customers—some of the most reliable and consistently paying customers will only work with you if you offer payment terms. Some large international firms, for example, often won’t pay for at least 120 days.

So if your customers are not struggling, why do they pay slowly?

Cash flow. The longer a company can hold on to its cash, the less it has to borrow, and the more it can grow. A big box retailer could purchase inventory and sell it before having to pay for that inventory, preserving liquidity. This, unfortunately, can have a disparate impact on smaller vendors. The larger the customer, the more leverage they have to negotiate slow payment terms.

Economic uncertainty can exacerbate this problem. If businesses fear that the economy is going to experience a downturn, the desire the preserve cash increases. 

These slow payment terms trickle down through the market. In the transportation industry, for example, freight brokers often pay carriers in 30-45 days. This is sometimes because the freight broker isn’t getting paid by the shipper for 30-45 days. Since the freight broker isn’t getting paid, they don’t have the cash on hand to float those receivables and pay the carrier, and thus the carrier has to wait.

The Hidden Costs of Slow Paying Customers

The cost of carrying accounts receivable becomes apparent when a business considers the prospect of running out of cash. Too little cash on hand means you can’t meet payroll, send vendor payments, or purchase inventory or materials for your next job.

But even assuming you have the cash to float receivables for 30, 60, or 90 days, while maintaining operations, there are hidden costs, such as the staff time devoted to collection efforts or cash forecasting. Additionally, there are opportunity costs that arise if the lack of liquidity causes you to pass on new deals. If you source your working capital from a line of credit, you have interest payments and bank covenants to consider.

Traditional Responses (and Their Limits)

So how should businesses compensate for slow paying customers? Many companies opt to use business credit cards or commercial lines of credit. These can be good options, but their usefulness is limited by your creditworthiness and how long you need to float your receivables. Most credit cards start charging interest after thirty days. The interest on lines of credit starts accruing immediately. Additionally, the risk associated with revolving credit means many banks won’t offer a line of credit large enough to meet your needs.

You could also consider extending your own payables with your vendors, but this isn’t always an option, especially if the relationship is new.

You could also incentivize your customers to pay early, using discounts such as 2/10 net 30 (2% off, if paid within 10 days). This can work, but it sacrifices margin, and doesn’t guarantee quick payment. Customers may not find the discount attractive enough to part with their cash early.

How Factoring Fixes the Cash Flow Problem

Selling unpaid invoices to a factoring partner solves the cash flow problem by aligning the time of payment with the delivery of the product or service. This reduces the wait from a matter of weeks or months, to 24-48 hours, or less. To put it in technical terms for your accountant, factoring is not a loan, but a way to shorten the cash conversion cycle by effectively removing Days Sales Outstanding (DSO), for a transaction fee of 1-4%—often less than the cost of accepting credit cards.

With factoring, you receive 80-90% upfront, allowing you to meet your obligations, and strategically allocate your cash. 

Learn more about factoring: What is Factoring? The Ultimate Guide to Business Invoice Financing

The Benefits of Factoring your Slow Paying Customers

Factoring is similar in cost to offering a quick pay discount, but it doesn’t depend on your customers to take advantage of it. The factoring company will reach out to your customers to verify the authenticity of the invoices, but other than that, the customer just needs to pay. This makes it easier for you to work with slow-paying customers and enables you to potentially take on larger contracts.

Additionally, with the influx of cash, you could take advantage of quick pay discounts offered by your suppliers, allowing you to strategically offset the cost of factoring, while improving vender relationships.

Lastly, factoring easily grows with your business. Your factoring facility is only limited by your accounts receivable. The more you sell, the more you can factor. This makes factoring more dynamic and scalable compared to a commercial line of credit.

Addressing Common Misconceptions About Factoring

Factoring has been around for centuries, but many businesses consider it a last resort. It’s true that factoring can be a great last resort, but it doesn’t have to be. It’s true that cheaper options exist—such as lines of credit. But these options may not be large enough or flexible enough to meet the need. A screwdriver and a power drill can accomplish the same goal. one is great on a budget, but as volume increases, you need a better tool. Factoring is similar—a commercial credit line might work for a time, and if it does, that’s great. But sometimes factoring really is the best tool for the job.

Some factoring companies position themselves more like last resorts and act more like debt collectors than financial partners. We recommend you avoid them. At Flexent, we can support struggling businesses, but our goal is to help lift your business out of distress. Ultimately, when your business is thriving, so are we.

Regardless, due to these stigmas surrounding factoring, businesses sometimes worry that the factor’s verification calls will signal to their customers that they are in financial distress and seeking a last resort. This worry can be placated by assuring your customer that factoring is a strategic move to reallocate your time away collections toward more profitable activities.

Read more about 6 Factoring Myths that Stop Businesses from Growing

When Factoring Makes the Most Sense

Factoring doesn’t fit every situation, but if you’re carrying commercial receivables for more than 30 days, it can be worth having a conversation. If you are experiencing rapid growth and are outstripping your line of credit, factoring can also be a great option. Take our quiz below to see if factoring might be right for you: