Businesses of any size rely on a steady stream of cash flow to keep their operations running smoothly. However, smaller businesses are especially susceptible to periodic cash crunches that occur when their accounts receivables get bottled up. In many cases, there is little that can be done to accelerate receivables outside of pleading with customers, which only annoys them. That is why it is important for a business to have ready access to cash for filling in the cash flow gaps. Fortunately, there is a fast-growing element of online lenders that cater to the unique needs and situations of small businesses. Recognizing the common challenge small businesses face with short-term cash flow crunches, an increasing number of online lenders offer short-term financing solutions specifically for those situations. Here’s what to look for in small business loans.
Factoring (Accounts Receivable Financing)
Accounts receivable financing, also referred to as invoice financing, is money lent to a business based on its accounts receivable. Accounts receivable financing tends to be a more expensive way to finance your business operations; however, it can ensure a predictable cash flow. Although there are many variations of AR financing, the most commonly used for small, less established businesses is factoring.
AR factoring is not really financing per se. Rather, it is the selling of assets (in the form of your accounts receivable) that provides the cash infusion. When the need for cash arises, the business submits its invoices to a factoring company, which decides which ones they will purchase. Typically, the business will receive 80% to 90% of the value of the invoices selected. The remaining value is reserved by the company until they receive the funds from the customer. At that point, the reserve funds are returned to the business less a 2 to 3 percent fee. Some factoring companies will also charge a factor fee that is calculated on a weekly basis. The fee, which is typically around 1 percent, can be charged each week the invoice is unpaid. Other types of factoring companies may advance as much as 100% of the invoices, requiring a weekly payment that includes fees, until the advance is paid.
When the business sells the invoice, it is actually removed from its AR because the factoring company owns it. It is totally responsible for collecting on the invoice (although the customer is not aware that it is a separate company).
Line of Credit
A growing number of online, non-bank lenders are filling the void left by traditional banks that tend not to serve the small business market, especially for lines-of-credit. With a traditional bank, both the business and the owners must have established credit histories, which make it difficult for many small businesses to qualify. Online lenders like will issue lines-of-credit up to $100,000 with minimal qualification requirements as long as your past business performance is strong enough. For example, one platform leader focused on online small business lending requires just $50,000 in annual revenue, two years of operation, no personal guarantee and a minimum personal credit score of 560. The application is completed online and approval and funding can take place within one business day. For most small businesses, a line of credit offers more flexibility and is better for controlling interest expense.
Online, non-bank lenders are also becoming much more aggressive in supplanting traditional banks in the small business short-term loan space. Traditional banks won’t consider a small business with no credit history or well-established track record of profits. However, some online lenders are more than happy to work with small businesses for their short-term financing needs. The big caveat is the cost of financing with online lenders is significantly higher than it is with traditional banks. The annual percentage rate (APR) can range from 25 to 40 percent based on the amount borrowed. But, the idea is to finance only what is needed and what can easily be repaid within a 12-month period or shorter.
All of these financing sources can fill a critical need for businesses that don’t have access to traditional financing sources; however, they can be expensive. Borrowing more than is absolutely necessary or that is beyond the capacity of the business to repay in a short period of time can worsen the cash flow problem. When a business gets in a position to qualify for traditional financing, either a line of credit or a short-term loan from a bank, it should convert the debt to lower its interest costs.