Your business’ overall health depends a lot on the working capital because it ensures liquidity for your day-to-day business operations and growth. However, it can be quite challenging to maintain a constant flow of working capital due to the time gap between receiving customer payments and paying the suppliers. Economic volatility and operational inefficiencies are also responsible for the lack of sufficient working capital. Thus, a business sometimes needs to borrow money for covering its working capital finances to fulfill the urgent cash flow problem.
Advantages Of Cashflow Financing
Working capital financing can take care of the payment gaps of the business. No additional collateral is required to obtain working capital finance as its an unsecured form of loan. You can get working capital financing approved within a shorter time than any other business loan, with flexible repayment terms. So, when you are facing a problem with your working capital fund, the various financing options will help you pass through this rough patch. If you are planning to apply for the working capital funds, then you have several options. The most popular ones are invoice factoring and merchant cash advance. Here we will discuss them in detail.
Invoice Factoring
If your customer is not paying on time and the working capital fund is in a bad shape, then you can choose invoice factoring. A factoring company will buy your unpaid invoices at a discount amount in cash. So, you won’t have to wait for months for the customers to pay; you can quickly convert your accounts receivable into cash. The amount you have lost for selling the unpaid invoices at a discounted price may be very small compared to the amount you will gain in the future by keeping your working capital flowing continuously.
Once you sell the unpaid invoices to a factoring company, you won’t need to chase after the customers for money anymore. It’s the responsibility of the factoring company to collect money from them. The factoring company typically has to pay about 70% to 90% of the invoice amount. There is something called ‘invoice factoring without recourse’, which means if customers don’t pay, then the factoring company can’t ask for the money they have given to you. As this option is riskier, the factoring company will discount your invoices more if you add the ‘recourse’ option. Invoice factoring is suitable for buying inventory or covering payroll.
Merchant Cash Advance
The merchant advance cash (MCA) form of working capital financing involves getting some upfront cash to your business in exchange of a share of future sales. You need to pay back the loan amount in monthly installments to the merchant cash advance companies, and these are subtracted as a certain percentage of debit or credit card sales till the cash advance is repaid.
Differences Between Invoice Factoring And Merchant Cash Advance
Invoice factoring and merchant cash advance both allow quick and collateral-free money to support the working capital of a business. However, there are some differences between them.
♦️ Quick Access To Cash
With invoice factoring, you get the money at once; whereas, in the case of a merchant cash advance, you get the money partly in advance from a third party, but the rest you will get after the customers pay back to the third party.
♦️ Cost
In invoice factoring, you need to compromise your profit a bit to turn your accounts receivable to cash. The business only needs to pay a small percentage of the total invoice amount for invoice factoring. But with a merchant cash advance, you will need to pay a fee to the third party, that is, the merchant cash advance company, for collecting the money from the customer. The business can end up paying a lot more than the money it has borrowed. It also adds as debt to your balance sheet.
♦️ Risk Level
Merchant cash advance is riskier than invoice factoring as it charges fees based on the projected sales, but in case of invoice factoring, the factoring company takes the existing invoice. So, the ‘uncertainty’ clause is absent here, making merchant cash advance riskier. If your business’s actual sales are not equal to the projections, then you may have to pay a lot of money.
♦️ Repayment Terms
In the case of merchant cash advance, you will have to repay daily or weekly from business revenue. This may cause strain on cash flow. You don’t need to pay anything to the factoring company as repayments.
♦️ Application Criteria
To apply for invoice factoring you the customers’ creditworthiness is the main focus, not that of the business’s. Getting approved for a merchant cash advance depends on the business’s revenue performance, not credit history. So, with poor credit score as well, a business can get loan.
♦️ Collection
The factoring company takes the responsibility of collecting money from the customers in case of invoice factoring financing. It’s a positive thing for the business. However, if the factoring company uses harsh techniques to collect the money, then your business’s reputation will be at stake. With merchant cash advance financing, the business is still responsible for collecting the payment from the customer.
♦️ Application Process
In invoice factoring, your invoices will be analysed to approve your loan. This is a labor-intensive task. MCAs get approved easily as acceptance of the application only depends on the revenue of the business, not credit history.
♦️ Applicability
The invoice factoring financing is suitable for businesses with strong accounts receivable and steady daily sales volumes, like those in the hospitality and retail industries. You can avoid debt with this option. You should consider MCA if the credit score of your business is low, revenue is credit/debit card sales-based, and a loan is needed quickly.
In constructions and other businesses where the gap between dates of project completion and payment is months apart, invoice factoring can ensure a steady working capital. Businesses using the B2B model and getting regular invoicing can apply for invoice factoring finance. As there will be steady invoices, it will be easier to maintain a consistent cash flow.
Invoice factoring and MCA are both good working capital financing options. It’s true that both provide fast working capital, but each comes with a cost. You need to assess both options by considering the long-term impact they will have on your business.
Conclusion
You must learn to manage your working capital well so that you can improve your earnings. You should negotiate with the suppliers to increase your creditor days so that you get more time to pay them. At the same time, you should reduce the debtor days, that is, the time customers take to pay. This way, you can run your business smoothly. Even if you need working capital financing, you will get it easily if your business manages money well.
