If your customers are not paying your invoices, then your accounts receivables will rise over time. That is a sure sign of trouble for small businesses, usually resulting in cash flow problems. And that is why, as a small business owner, you must keep a close eye on your accounts receivables, and focus on collecting your invoices on time.
However, in an extreme case, business owners have to resort to the practice of factoring. As explained in the Wikipedia –
Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business.
Factoring converts the accounts receivables into instant cash, and saves your from the cash crunch. However, factoring has its downsides –
- The creditor who “buys” your accounts receivables will often buy it at 5% to 15% discount. So you are losing a large margin right away.
- More importantly, factoring has a certain taboo attached to it. If they know you have resorted to factoring, then they will know your business is in desperate need for cash. Not a good perception for the potential customers and even creditors to have of you.
And that is why this idea seems pretty interesting to me. The Receivables Exchange is a online exchange for anonymously buying and selling accounts receivables. They claim to give factoring rates of 0.5% to 3%.
It is a great idea, but I really suspect that they will be able to provide such low rates. TRE is essentially acting as a credit rating agency for small businesses. The rates will depend on how well the buyers (lenders) trust the rating stamp provided by TRE. Why would a lender buy an accounts receivable for such low rates as 0.5% or even 3% given the risk he is taking?
An interesting idea nevertheless.