Outsourcing Accounts Receivable
to Increase Cash Flow
Outsourcing Accounts Receivable
to Increase Cash Flow
In the current economic environment, small and medium-size businesses
are facing unprecedented challenges in their ability to access the working
capital necessary for their survival. This white paper will review the
implications of the state of the economy on small and medium-sized
companies and present solutions for how businesses can outsource their
accounts receivable and credit administration functions to their lender so
that they may vastly improve their cash flow.
The Effects of the Economic Crisis on Small to Medium
Sized Companies
Times have been tough. Following the collapse of the subprime mortgage market in 2007, the worst financial crisis in eighty years has rippled around the world.1 Most Americans have never experienced a
recession of this magnitude and most businesses have never had to endure the consequences of such a downturn. An economic forecast, compiled by the Wall Street Journal, predicts a continued decline of GDP for the first quarter of 2009, followed by flat growth in the second quarter and meager growth for the second half of 2009.2
To make matters worse, we’re also facing a serious banking crisis. Twenty four banks failed in 2008, and most of the major established financial institutions are either filing for bankruptcy (e.g., Lehman
Brothers) or accepting considerable bailout packages from the federal government (e.g., AIG, Citigroup). Credit is more difficult to obtain than ever. Credit standards are becoming more and more stringent, and borrowing is essentially becoming restricted to very conservative projects for the very creditworthy.3
Restrictions on lending are having a dramatic impact on small to medium-size businesses. In addition to weathering decreased consumer spending and stricter credit requirements, companies are facing higher rates on loans and the loss of funding sources from real estate. Cash flow has become the biggest threat to survival for small and medium size businesses. Many companies are struggling to make payroll. In a September 16th 2008 issue of the Wall Street Journal, Tom Markel, chief executive of iBank.com, suggests that small businesses will increasingly need to look to other sources of funding (Covel, 2008). But what other sources of funding exist?
1 Fitzgibbons, Patrick. “Germany, China, U.S. Feel Pain of Global Downturn.” Reuters. November 13, 2008. http://www.reuters.com/article/GCA-CreditCrisis/idUSTRE49N5VU20081113.
Solutions for the Surviving the Recession and the Credit Crunch
If cash flow is the challenge, where can businesses turn to gain more working capital?Basically, there are only three ways to increase cash in a business:
Increase revenue
Secure funding from a bank or other source Outsource accounts receivable
As we’ve reviewed, given the current economic conditions, businesses are finding it difficult to increase revenue (due to restricted consumer and business spending) or secure bank funding (due to stricter credit requirements). The option that offers the most benefits is outsourcing accounts receivables. Outsourcing accounts receivable is similar to a consumer retailer accepting a credit card for payment—it enables the seller to immediately receive payment while offering extended payment options to the buyer. This option can allow companies to access working capital and lower expenses associated with their credit administration.
How can outsourcing AR result in increased cash flow?
If your company is like most, much of your cash is tied up because you’ve been lending it to your customers through something called trade credit. Trade credit is the ability to purchase goods and services now and pay later. Typically, the seller sends an invoice requesting payment in a pre-determined number of days. Essentially, it’s a free short term loan from the seller to the buyer.Currently, trade credit transactions are a significant part of the American economy. Of the $20 trillion exchanged in B2B transactions in 2007, over $19 trillion were completed through trade credit. Only 3% of B2B transactions were made with credit cards while 97% of B2B transactions were made with trade credit, as you can see in the chart below.
Personal Credit Card
$300,000,000 Corporate Credit Card$300,000,000
Payment for B2B Transactions
in 2007:
B2B Trade Credit $19,400,000,000
In a more stable economy, sellers can afford to fund these “free loans.” However, in a credit-constrained economy, outsourcing accounts receivable is a viable alternative for increasing capital.
Outsourcing accounts receivable reverses the flow of cash out, and increases the cash flow in. You eliminate the costs associated with waiting 45, 60, or 90 days to get a return on capital with the payment for your goods or services. That gives you more time to allow your money to work for you without compromising the benefits of longer credit terms for your customers. As a result, your business has the cash it needs to make payroll, increase inventory, or expand. Plus, there are significant savings associated with outsourcing administrative functions, taking discounts for early payment, and
eliminating losses from bad debt.
You might be thinking, “That sounds like factoring. Isn’t that costly and doesn’t it make my organization look bad?”
How outsourcing accounts receivable differs from factoring
Many businesses may be familiar with the concept of “factoring” receivables in exchange for working capital. But outsourcing accounts receivables has several distinct advantages.As we’ve mentioned, outsourcing accounts receivable allows you to reduce administrative costs—in fact, any fees that you pay to a lender for outsourcing are usually offset by these savings. By comparison, when factoring receivables, you stand to forfeit a portion of your accounts receivables based on how long they take to collect. Also, unlike outsourcing AR, with factoring, you also risk customer loyalty because your customers don’t have any flexibility in their credit terms.
When organizations make a strategic decision to outsource accounts receivables, the market recognizes their expertise, versus the negative reactions to a tactical decision to factor your accounts. As a result, outsourcing accounts receivable bears none of the stigma attached to factoring.
How can I improve cash flow by outsourcing accounts
receivable?
By partnering with AdvancedAR, you can positively impact your business by outsourcing accounts receivable processes (for B2B transactions only) to financial institutions. Your business is paid within a few days by the participating bank, rather than in 30, 60, or 90 days by your buyers. Your business has working capital immediately, and its cash conversion cycle drastically improves. Plus, AdvancedAR offers businesses additional sales power with sufficient capital to make sales when longer payment terms are required by the buyer (for example, a large megastore).
Example: Typical customer with $1 million a year in B2B sales volume and a 45-day DSO (days sales
outstanding) can save:
Credit administration savings of $48,000 Discounts for early payment savings of $3,000 Eliminating losses from bad debt savings of $5,000 Estimated 5% increase in sales of $50,000
Net benefit is $56,937 even after total fees
As we mentioned earlier, outsourcing accounts receivable is similar to a consumer retailer accepting a credit card for payment. By accepting a credit card for payment, the seller does not have to
worry about the credit of the buyer, nor does the seller have to incur the costs associated with administering the account or bad debt—all of this work is done, for a small fee, by the credit card issuer. As a result, over 95% of all consumer retailers have outsourced their accounts receivable and credit administration function by accepting the credit card.
Over the next decade, as lenders and businesses become familiar with the simplicity of accounts receivable financing (also called trade credit financing), it will be the model by which virtually all B2B transactions will be conducted.
Case Studies:
Consumer Products Company
This consumer products company was looking to sell to big box retail outlets such as Wal-Mart, Target and Lowes. The company identified a new product for the consumer market that would amount to $1.5 million in increased sales. However, the retailer required 90 day payment terms. The company estimated an initial investment of over $250,000 to get the first products on the shelf with a subsequent receivables balance of over $350,000. AdvancedAR allowed the company to move forward with the opportunity. By accelerating buyer to seller payments to 4 to 8 days, AdvancedAR allowed the company to increase their cash flow. The company had the funds to invest in the development and sale of a new product.
Irrigations Systems Subcontractor
This subcontractor specializes in the installation of irrigations systems, sidewalks, and landscaping. They were hoping to grow their business from $2 million to $8 million in 2007. They needed
additional financing to expand their business, but they didn’t want to use physical assets as
collateral. AdvancedAR provided a solution. By outsourcing their accounts receivable, they were able to reduce costly, time consuming administrative duties in collecting payments, while increasing their cash flow immediately. With the increased cash flow, this small business was able to pay their suppliers earlier and take advantage of additional discounts. AdvancedAR helped them take their small business to the next level.
Conclusion
The dire state of the current economy is forcing businesses to consider alternative sources of funding. Outsourcing accounts receivable is a viable way to improve cash flow to sustain your business through these difficult times, but that’s not the only reason it’s a good idea. Outsourcing accounts receivable also gives your company a competitive advantage by allowing you to offer the best trade credit terms possible to your customers. Using AdvancedAR can help you can grow sales while improving the operations and financial condition of your business.
