Although the concept of factoring an obligation has been around for hundreds of years, fur hunters in the old days used it when they brought their furs to market, the majority of people running a company are unaware of this finance tool. Often these days we get a call too late to help.
The brand new commercial financing concept of cash advance – offering money based on the potential of future income doesn’t even have a settled upon industry name but that isn’t stopping business owners from muddying up their balance sheet with these loans.
See if you can relate to this scenario;
Hordes of incoming emails and phone calls offering overnight loans by just producing the last six months of your company bank statements. A company finally succumbs to the siren song of easy debt and now has a net term liability on their balance sheet, but more importantly they have pledged their business assets (read U.C.C.) to the cash advance lender. These lenders are so aggressive they will line up behind the original loan and keep offering more loans in succession. Now there are two or three sometimes more cash advance loans ticking the business checking account on a daily, weekly or monthly basis.
Now what?
In order for a more securitized form of capital to come in all these loans have to be first unwound and paid off. But this creates a conundrum – the company doesn’t have the capital to pay off the cash advance loans all at once, it will ruin the operational cash flow.
What might have seemed like a good idea at the time ends up being working capital handcuffs in short order. Don’t get me wrong, I believe cash advance loans fulfill a purpose, one that history tells us is a viable reason to borrow money – to make a capital purchase and finance the cost over a period of time. Factoring invoices is not a good tool to finance a purchase, but I wish the cash advance crowd would understand that a term loan is not the proper way to cash flow a long term ongoing contract or purchase order that requires continued supplies of labor and material.