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Are longer invoice payment terms from your customers depleting your working capital? Here are six alternative financing solutions to get you through the squeeze.
Today, many businesses are feeling stretched — and it’s not hard to see why. Russia’s invasion of Ukraine, the highest inflation in 40 years and rising interest rates signal that a recession could be on the horizon. In an October 2022 article by The Wall Street Journal, surveyed economists believed there’s a 63% chance of a US recession in the next year.
Uncertain economic times are prompting large enterprises to extend payment terms with their suppliers. By prolonging invoice due dates, companies can maintain more cash on hand to navigate inflation and other economic challenges more securely.
However, this creates a significant cash flow burden for suppliers. If you’re a small to mid-sized supplier, waiting 90 to 120 days, or more, to receive invoice payments can cause severe cash flow shortages. In many cases, this can impact your ability to pay bills, restock inventory, pay staff or invest in growth opportunities. At worst, it could cripple your business.
To make matters worse, many small to mid-sized businesses lack the credit history and other financial requirements needed to secure traditional bank loans. With rising interest rates, you also may be unable to afford loans. Where does that leave your business when customers extend payment terms?
Fortunately, there are alternative financing options that can keep your business running — and even growing — as customers request longer payment periods.
A business line of credit (LOC) can provide a flexible, as-needed financing solution and safeguard your business against cash flow problems — especially if your customers extend payment terms regularly. LOCs offer “revolving” credit, which means that you can draw funds at any time up to a predetermined limit and pay it off when you can. As with credit cards, paying off your balance replenishes the maximum accessible funds, and you pay interest only on the amount used.
Obtaining a business LOC is fairly straightforward. You can apply for a business LOC from a bank or online lender and agree to an interest rate and credit limit. Then, you can use the funds when necessary and pay off the balance according to your lender’s terms. Requirements and terms vary across lenders. Banks may require a credit score of at least 600 and yearly revenue benchmarks, while online lenders may be more flexible but have higher interest rates and stricter payment schedules.
A LOC might be ideal for your business if you know your customers will ask for longer payment terms but aren’t sure when. If you’re already struggling with longer payment terms and have immediate funding needs, a short-term business loan could be a better option.
Short-term business loans provide a lump sum of cash upfront that borrowers can pay off in monthly, weekly or daily installments. Terms typically span three to 36 months and charge interest rates starting around 8%. Loan amounts can range from $2,500 to $500,000.
This financing option is safest for companies with guaranteed revenue in the near future — which is why it’s ideal for addressing long payment terms. For example, if extended payment terms mean that you can’t make payroll, a short-term business loan can give you the funds needed to pay staff while you wait for customer payments to clear accounts receivable.
However, short-term loans aren’t ideal for all businesses. Cash flow problems caused by seasonal downswings and unexpected circumstances such as bad weather could impact short-term revenue. If you can’t make loan payments, accumulating interest and late fees will damage your credit score.
Additionally, small to mid-sized businesses typically need to prove two years of business activities, a history of substantial revenue and a credit score of 600+ to qualify for short-term loans. If you don’t qualify, online lenders may offer lighter requirements but more expensive terms.
If you fail to qualify for LOCs and short-term business loans, you might consider secured financing. LOCs and short-term loans are typically unsecured, meaning no collateral is required. However, secured loans, which require collateral, could be an option if lenders see considerable risk in your business.
All lenders, including banks and online alternatives, see credit scores as the most accurate indicator of a borrower’s risk. If your credit score is lower and there are no other financial indicators to compensate for it, lenders may require an agreement allowing them to seize your assets upon default.
However, incurring debt — whether it be through a business line of credit or short-term loan — isn’t the only way to address cash flow problems caused by longer customer payment terms. You can also fuel cash flow with solutions tied directly to your accounts receivable, such as invoice factoring, discounting or early payment programs.
Invoice factoring involves selling your outstanding invoices to a third-party company (called a factor) at a discount. Factors buy your outstanding invoices for 70% to 90% of the invoice total upfront. Then, the factor gives you the remaining amount, minus factoring fees (typically 1%-5%), once it receives payment from your customer. This allows you to get cash sooner so you can increase working capital and meet operating expenses.
This may be a good option if your business doesn’t qualify for a LOC or short-term loan. Factors are usually more concerned with your customer’s credit score and financial history because the factor’s priority, once it owns your invoice, is to get paid by the buyer — not you.
Invoice factoring has several drawbacks, however. Once you’ve sold an invoice to the factor, the factor decides how to collect invoice payments and interact with your customers. This could impact your customer relationships. Factors are also notorious for hidden fees and confusing agreements.
Invoice discounting is a cost-effective alternative to factoring, eliminating the need for a third-party factor. With invoice discounting, your customers receive a small discount as an incentive to pay you earlier than your agreed terms. In many cases, this option costs only as much as the discount, removing the need for additional debt or fees. The cost of an invoice discount is often worth the cash flow boost when customers extend payment terms.
There are three types of invoice discounting methods:
Static discounting gives customers a fixed discount rate if they pay within a certain number of days after receiving the invoice. Static discounting terms usually look like: 2/10, net 30. This translates to: “Pay me in fewer than 10 days and I’ll give you a 2% discount. Otherwise, the full balance is due within 30 days.”
Sliding scale discounting allows customers to pay an invoice at any time within your payment term. The discount adjusts at a predetermined rate based on when they pay — the sooner your customer pays, the bigger the discount.
Dynamic discounting considers the payment date as well as supply and demand to determine the customer’s discount rate.
Sliding scale discounts offer a more flexible payment window for customers than static discounts. However, dynamic discounting gives you the most control over your discount rate. Because it considers supply and demand, dynamic discounting can also provide a more competitive rate than static or sliding scale discounts.
Invoice discounting is traditionally implemented as an addition to your invoice’s credit terms. This puts the onus on your accounting team to ensure that customers are adhering to early payment terms if they decide to take a discount.
Alternatively, you can use an early payment program, which is run by a partner institution via an online portal. These solutions usually make invoice discounting more efficient and straightforward for you and your accounting team. They also simplify a sliding scale or dynamic discounting approach. With these solutions, you typically leverage an early payment program that is already implemented by your customer.
For example, here’s how it works with C2FO’s Early Payment platform: Invoices from your participating customers are automatically uploaded to the platform. You choose which invoices to discount and set your discount rate for early payment. If your customer accepts the offer, you receive early payment in as little as 48 hours with no additional fees.
Rising inflation and other economic factors have most likely caused your customers to request longer payment terms in the last couple of years. Funding options such as business lines of credit, short-term loans, secured loans or invoice factoring may be good alternatives for navigating extended payment terms if you don’t qualify for traditional financing.
However, if you have a small to mid-sized business, it’s possible that you don’t qualify for alternative financing — or can’t afford invoice factoring. For these businesses, invoice discounting solutions such as early payment programs are a viable, cost-effective way to fuel your cash flow.
Do your existing customers already use an early payment program? Find out here.
This article originally published July 2020, and was updated November 2022.
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