The Disadvantages of Selling the Receivables as the Only Source of Cash
Original post by Eric Feigenbaum of Demand Media
In many lines of business, services are rendered and goods delivered before a client or customer pays for them. A company can easily accumulate thousands if not millions of dollars in accounts receivable. Although receivable revenues can make a business look successful and profitable on the books, at some point the company must collect. One way to get cash on tough-to-collect invoices is to sell receivables to a factoring, collections or finance company. However, making this the primary strategy for cash flows can be dangerous.
Factoring and finance companies buy receivables at a discount. By selling a receivable invoice, a company instantly gives up profit. Although some money is better than none and sometimes less money today is better than larger revenues next week -- relying on the discounted sale of receivables a company's sole income makes the business less profitable than it could be.
Despite building a diverse customer base, a business that decides to only sell receivables becomes reliant on one or a few sources of revenue. One or a few factoring companies become the company's real clientele. Accordingly, if one or any receivables buyers fold or decide to no longer buy, the selling company will find itself in immediate jeopardy. Diverse sources of revenue help buffer problems, prevent losses and ensure a business' overall stability.
Typically, a company needs to sell its receivables when it has trouble collecting. If a company has turned to selling receivables as a sole source of income, chances are it has mostly poor paying and deadbeat clients. Factoring companies and collectors only buy receivables when they believe they can profit. That means at least a good portion of the receivables have to turn to cash. A company that regularly sells difficult-to-collect or non-paying accounts receivable will eventually lose credibility with factorers and collections agencies. Eventually, cash sources will dry up.
Capital and Sales
A company interested in capital to grow and expand won't do well if its revenues all stem from selling receivables. Lenders and investors alike will have concerns about a business that can't collect the full value of its revenues directly from customers. A business owner looking to sell will find the same is true of potential buyers. Those considering putting their money on the line want reasonable assurances their risk will pay off. A company that can't collect its own receivables is especially risky.
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About the Author
Eric Feigenbaum started his career in print journalism, becoming editor-in-chief of "The Daily" of the University of Washington during college and afterward working at two major newspapers. He later did many print and Web projects including re-brandings for major companies and catalog production.