Explains how cash flow can sometimes act like a yo-yo – one day its up the next day its down. Factoring can be a solution to this yo-yo effect.
Is your cash flow like a yo-yo – one minute it’s up the next it is down?
Take an ordinary small to medium sized business with growing turnover – orders are up and the business has the opportunity to increase profitability. But still one thing holds it back – its CASH FLOW.
Look at a typical monthly cycle of this business:
In the first week of the month several of its major customers settle their account. The business is able to pay some of its suppliers and the overdraft is within the limit set by their bankers. The yo-yo is up.
In the second week they receive a large order which will require the purchase of additional raw materials from a supplier who will need to be paid up front to keep the account within its credit limit. Unfortunately the bank overdraft limit has been reached and therefore the materials required cannot be purchased and therefore the order has to be turned down. The yo-yo is down.
In the third week a concerted effort is made to collect money in on overdue accounts in order to provide sufficient funds to pay monthly wages at the end of the month. The yo-yo is up.
The final week of the months sees the wages paid taking the overdraft back towards its limit with quarterly VAT due at the end of the month. This payment will have to be delayed to the first week of the following month when payments from customers settling end-of-month accounts are received. The yo-yo is down.
And so it goes on until eventually the yo-yo does not come back up.
So what is the solution? Three possible answers come to mind.
1) Put more of your own money into the business if you have any. A second mortgage on your home perhaps.
2) Ask an outside investor to put in the money – but this could mean parting with some of the equity of the business – future profits would have to be shared.
3) Borrow more money from the bank – but the bank will want more security before they will increase funding – have you got any to give?
BUT IS THERE A FOURTH SOLUTION – FACTORING
Factoring releases cash tied-up in the sales ledger. Therefore as the business expands so does the funding available thus beating the cash flow yo-yo affect.
What is main source of day-to-day cash into the business (in a lot of instances the only source)? The answer is the sales ledger. Where an enterprise sells business to business this is normally done on credit terms. Therefore you’ve made the sale, created a profit but you don’t yet have the cash. And it is this that creates the yo-yo affect on the cash flow needs of the business. With factoring the cash is available as you need it rather than when your customers choose to pay you thus allowing you to control your cash flow needs.
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