Delayed payments can easily strain a business’s cash flow—what more if customers don’t pay? Non-payments are a financial nightmare for business owners who have to write them off as bad debt. They’re a major drain on a company’s financial resources, but a strategic solution like factoring services can help cushion the blow.
In this post, we discussed more about debt, how to determine it on your business, and how factoring can reduce its impact on your finances. Read on and learn how you can minimize one of the most dreaded financial problems among business owners!
What is bad debt expense?
Bad debt refers to the exact accounts receivable that your company expects not to collect anymore. It’s possible that your customer went bankrupt, is in a state of insolvency, or has disputed the invoice over the quality of your goods or services.
When all collection efforts fail, a business will simply accept this as a loss and write it off as a bad debt. This will affect your company’s balance sheet.
On the other hand, bad debt expenses are the estimated or forecast loss for the period. This is based on previous business data and will be reflected in your profit and loss (P&L) statement.
Bad debt expenses will be recorded as an operating expense, which is deducted from your net income. It can be added as an allowance for future non-payments to safeguard your business from ‘surprise’ losses. By offsetting potential bad debts, you’ll have a cushion to maintain your business’ financial health.
How to determine bad debt expense
Businesses use two methods on how to calculate bad debt expense: direct write-off or the allowance method.
With the direct write-off method, you directly consider the bad debt an expense. However, this method is more suitable for smaller transactions as it doesn’t align with GAAP standards.
Meanwhile, the allowance method is ideal for businesses that rely on credit sales, where customers pay at a later date. The exact bad debt expense is calculated as a percentage of bad debt or through the account receivable aging technique. The longer an invoice remains unpaid, the less likely it is to be collected.
How factoring helps reduce bad debt expense
While bad debts are unavoidable to some extent, factoring can help lessen its financial impact to your business. A Florida factoring company can help reduce bad debt expenses through several ways:
1. Free credit checks
Factoring companies like Factoring Express LLC provide free credit checks on potential customers to assess their creditworthiness. This will let you see high-risk clients, reducing the possibility of dealing with customers who might default on payments.
By identifying which customer has a high chance of non-payment, you can make smarter decisions when taking new orders. This way, you won’t have to deal with bad debt and the expenses it entails.
2. Non-recourse factoring
In non-recourse factoring, the factoring company assumes the risk of non-payment if a customer fails to settle the factored invoice. This means your business doesn’t have to write it off as a bad debt as the factor absorbs the financial loss.
Non-recourse factoring allows you to reduce bad debt expenses while enjoying a more predictable cash flow.
Still, you should know that non-recourse factoring has stricter requirements and higher service fees. But compared to the risk you’ll relinquish, it’s well worth the savings in the long run.
3. Professional collection management
Factoring companies have professional collection teams handling customer payments. Aside from reducing the administrative burden of your business, they also implement effective collections processes for higher recovery rates. This reduces bad debts, not to mention you no longer have to chase down payments on your own.
You can focus on core business operations while the factoring company handles the collection. Customers will be informed of the factoring service through a Notice of Assignment (NOA), which includes their new payment terms.
4. Flexible payment terms
Factoring allows you to offer better payment terms to customers, giving them more options to settle their invoices. By receiving a cash advance against the unpaid invoice, businesses no longer have to demand quick and one-time payments from customers.
The instant funding from factoring helps companies offer more accommodating payment terms, such as installments or longer turnaround periods.
5. Less reliance on traditional loans
In some cases, businesses take out traditional loans to pay off bad debts. Some also opt for debt consolidation to simplify their finances or find more favorable terms.
While this strategy works for many, it has its share of challenges. First, bank loans come with interests, collateral requirements, and the risk of debt accumulation. When this happens, your business will be trapped in a cycle of debt, making it even harder to achieve a stable cash flow.
This is where factoring comes in handy. You can sell other unpaid invoices to a factoring company to inject instant cash to cover bad debt expenses. While it will not fix already-existing bad debts, immediate funding through factoring will give you a financial allowance for potential losses.
Additional benefits of factoring to your business
Aside from helping your business reduce bad debt expenses, factoring also brings in more benefits, including the following:
1. Reduces administrative tasks
No more endless desk work to chase down payments! The factor assumes the responsibility of collection, so you can focus on running your business with the cash advance you receive against your eligible invoice.
On top of that, factors like Factoring Express LLC provides back-office support for more efficient cash flow management.
2. Enhances your balance sheet
By converting accounts receivables into cash, you’ll reduce your liabilities and achieve a more favorable debt-to-equity ratio. It also means you can pay suppliers and vendors on time, improving your creditworthiness.
In the long run, this will give you better terms once you seek other forms of financing in the future.
3. Funding with limited credit history
Did a previous bad debt hurt your credit score? With factoring, you can still get instant funding regardless of your current credit history.
Factors check your customer’s creditworthiness, not yours. As long as your customer has the ability to pay, you can convert their invoices into cash. This will eventually help you achieve steady cash flow and rebuild your credit.
4. Quick application and processing
Factoring companies offer an easy and straightforward application. You can get your account approved on the same day, and you can start factoring in and funding invoices.
This simple process is ideal for startups and small businesses that don’t have the luxury of time to queue up at banks to take out loans. Above all, factoring doesn’t incur interest or require monthly payments.
5. More growth opportunities
With steady funding, you’ll have the confidence to grab business opportunities; otherwise, you’ll decline due to delayed payments. This means you can take on bigger contracts and drive more profits to your business.
In the long term, this spells expansion and scalability for your company. Instead of waiting for customer payments, you can leverage factoring to give you the working capital for new projects.
Ready to get started?
If you’re dealing with bad debt and want to improve you cash flow, Factoring Express LLC is here to help. We can convert your outstanding invoices into cash, so you’ll have more funds to balance out the losses. This way, you can go business as usual with enough funds to fuel your operations.
Contact us today and enjoy quick business funding tailored to your business needs. You’ll also get a 1-week free trial when you apply today!
