Factoring Explained: How to improve the cash flow of your business

Cash flow is one of the most common pain points of B2B businesses. Maintaining enough capital is essential to every aspect of running a business, from producing goods to paying staff.

All merchants, though, will inevitably have to deal with customers who don’t pay on time. In the worst case scenario, some customers may not pay at all. The knock-on effect of this uncertainty is that B2B businesses sometimes have to scramble to find the cash needed to remain solvent. That’s why it’s important that business owners understand the options available to them.

Accounts receivable and merchants’ risk

Accounts receivable is intrinsically linked to invoice payment, which is by far the most desired payment method among B2B businesses. In a typical transaction, a merchant will deliver goods or services to a customer before they’ve received payment. In turn, the customer has a designated period of time (usually 30 days or more) to pay the merchant for the amount listed in the invoice. This outstanding debt is known as accounts receivable, and is listed on the merchant’s balance sheet.

While this arrangement enables customers to get the products they need in a timely manner, it can cause some obvious problems for merchants. First, the very nature of invoice payment means it’s the merchant who takes on the risk and whose cash flow is therefore affected. Second, if a customer doesn’t meet the payment deadline, the merchant will have to invest time and effort to remind the customer and chase the payment. Third, in a worst case scenario, a customer who is unable to pay at all may default on their debt. In this instance, there’s no guarantee a merchant will be able to recoup the entirety of the money they’re owed – or at the very least, they may be forced to take legal action (which costs time and money).

B2B businesses, unlike those in B2C, tend to have fewer clients, each of whom has a much higher basket size on average. Because of this, one or two late payments or instances of payment default can derail a company’s cash flow. So what sort of solutions can help B2B businesses remain solvent?

Business loans and receivables financing

To maintain a steady and sustainable cash flow, B2B businesses might traditionally consider obtaining a loan from a bank. This might enable merchants to sufficiently cover their day-to-day operating costs or invest in their business so they can continue to grow.

But traditional bank loans don’t entirely solve the problem of risk. While it’s true that the extra cash can help steady the ship if customers pay late, the merchant is required to offer assets as collateral in the case of default. Even for merchants who are approved for a loan, the process can be time-consuming, which is counterintuitive to their needs for a rapid injection of capital.

An alternative, quicker solution is receivables financing. In this scenario, the loan (usually worth 70-85% of a merchant’s accounts receivable) is secured against the outstanding debt, rather than an existing asset. In exchange for taking on the risk, the lender usually charges a much higher interest rate than a bank offering a traditional business loan. For some businesses, this greater cost makes such a loan unrealistic.

The advantages of invoice factoring

More and more B2B businesses are turning to an innovative form of receivables financing to address their cash flow needs: invoice factoring. In this setup, a merchant sells their accounts receivable to a factoring company – this is crucially different than taking out a loan against existing assets or expected income.

Merchants immediately receive a cash injection worth 96-99% of their accounts receivable, while the factoring company keeps the remaining amount (called the Merchant Discount Rate or MDR). The MDR is determined by a number of variables, including average basket size and creditworthiness.

Because factoring companies are buying the outstanding debt of a merchant’s accounts receivable, they’re taking on the full risk. As such, they also tend to offer additional services related to collection of payments. For merchants who are burdened by the administrative cost of collections, this is a huge selling point.

Of course, B2B businesses who use a factoring company may come under increased scrutiny from their customers. Long-standing clients may interpret the merchant’s efforts to minimize risk as an indictment of their own creditworthiness. It is essential, then, that merchants choose a factoring company that values open communication and will work hard to maintain existing client relationships.

Buy Now, Pay Later

For B2B businesses, invoice factoring is an attractive, modern solution to their cash flow headaches. This is largely due to the fact that invoice payment has long been the norm in B2B transactions.

Yet while B2C companies have developed innovative technologies to improve the customer experience, B2B companies have lagged behind. Some 95% of B2B businesses want invoice payment as an option in their online shops, but just 45% currently offer it to both new and existing customers. Buy Now, Pay Later from Mondu was designed specifically to bridge this gap.

This solution enables B2B businesses to protect themselves from payment default, minimize their administrative burden, and confidently manage their cash flow, while still offering customers their favorite payment methods. What’s more, merchants who use Mondu can increase their conversion rate by up to 40% and their shopping cart size by up to 60%.

We help seamlessly integrate the solution in your online shop and support you every step of the way, so that you can focus on what’s most important: doing business.

Definitions

Cash Flow

Cash flow is the net amount of money that is transferred into and out of a business over a given period of time. It can be broken down further into three different activities ( operating, investment, and financing) and is a common measure of the health of a business.

Invoice Payment

The most popular payment in Germany, invoice payment is when a buyer receives a product or service immediately after purchase, but is allowed to pay for the goods later. Anyone who has ever made a private order through an online shop is likely familiar with this form of payment. 

Payment terms can vary and are determined by the seller. B2B invoice payment operates similar to B2C transactions, with the buyer paying for goods only after they’ve received them.

Factoring

Factoring is a form of financing, in which outstanding receivables are sold to a third party. The seller receives liquidity immediately, while the factoring company takes on the default risk of the receivables. In legal terms, this is known as a debt purchase agreement.

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