Summary: Management consulting companies are often started by entrepreneurs with long performance track records. These companies can be a lucrative opportunity, though they are expensive to operate.
Most small and growing management consulting companies don’t qualify for business financing. Instead, they are financed using their retained earnings. This situation limits the company’s ability to grow and take on new clients.
This article discusses how management consulting companies can use invoice factoring to finance operations and growth. It covers the following:
- Do you have cash flow problems?
- Invoice factoring improves cash flow
- Advantages of factoring
- Things to keep in mind
- Pre-billing and milestone-based billing
- Do you qualify?
1. Do you have cash flow problems?
Management consulting companies often work with corporate and government clients. As part of their contract terms, the consulting company must give their clients 30 days to pay their invoices. This payment arrangement is typical for commercial contracts.
These terms create a 30-day gap between when an invoice is sent to a client and when a corresponding payment is received. This situation is not a problem for established management consulting companies. They can rely on their cash reserve to cover payroll and other expenses.
Offering payment terms can create a problem for small consulting companies that are growing quickly. Their expenses can get ahead of their revenues, at least temporarily. This situation creates a cash flow problem that can grow if not handled correctly.
a) Should you offer an early payment discount?
Some management consulting companies can improve their cash flow by offering an early payment discount to select clients. This approach can work well if your cash flow problems are minor.
However, an early payment discount may not be a solution if the cash flow problems are ongoing. Fixing an ongoing cash flow problem usually requires financing. An effective tool to accomplish this goal is invoice factoring.
2. Invoice factoring improves cash flow
Invoice factoring enables you to finance your invoices from clients who pay on net-30 terms. It bridges the gap between invoicing and payment and provides funds for payroll and other important expenses.
This solution is available to small management consulting companies, has simple qualification requirements, and can be deployed quickly.
a) How does factoring work?
Most factoring companies don’t provide factoring as a loan. Instead, they buy your invoices in two installments.
The first installment, called the advance, covers 85% to 90% of the total invoice value. The factor deposits the advance shortly after they process the invoice.
The remaining 10% to 15%, less the factoring fee, is deposited into your account once your customer pays the invoice. This second installment settles the transaction. Factoring can be used until the consulting company’s cash flow stabilizes.
Read “What is Factoring?” and “How Does Factoring Work?” to learn more.
3. Advantages of factoring
A factoring solution offers several advantages over comparable products. The most important advantages include the following:
a. Improves cash flow quickly
The most important advantage is that factoring improves your cash flow quickly. It provides funds to help you cover payroll, which is your most important expense.
b. Adapts to growing businesses
Your financing line’s availability is linked to your company’s revenues. The line can adapt to increased sales as long as your invoices meet the requirements for funding. This feature is important for companies that are growing quickly.
c. Quick deployment
Most factoring lines can be deployed quickly and usually much faster than comparable solutions. This rapid deployment helps companies that need funds to handle an urgent shortfall.
d. Simple qualification
Qualifying for a factoring line is simpler than obtaining a line of credit of a similar amount. This solution is designed to help small companies that may not be able to qualify for bank financing.
4. Things to keep in mind
Factoring may not work for every management consulting company. Business owners should keep the following in mind if they are evaluating a factoring program:
a) Works with a specific problem
Factoring lines offer an effective way to finance a company whose cash flow problems are due to slow-paying invoices. Factoring does not offer much help if the cash flow challenges are due to other reasons, such as low profitability.
b) More expensive than bank financing
Factoring is more expensive than conventional bank financing. It works best for companies whose profit margins exceed 20%. This should not be an issue for management consultants since they usually have high profit margins.
5. Pre-billing and milestone-based billing
Some management consultants pre-bill for some services. For example, a management consulting company may invoice a client for monthly services at the beginning of a month, before services are rendered. These invoices cannot be financed until the service has been delivered and accepted by your customer.
Consulting companies involved in long-term projects may also invoice when certain milestones are met. Although these invoices can be financed, only a few factoring companies support this type of invoicing.
6. Does your company qualify?
The qualification process for an invoice factoring program is relatively simple. In general, factoring companies consider five things:
a) Do your customers have good credit?
Factoring companies can finance invoices only from customers with good commercial credit. This shows the finance company that your customers have a track record of paying their invoices on time.
b) Can your invoices be factored?
Invoices can be financed if they are for final sales and have no contingencies. Additionally, the client must have received the services and be satisfied with them.
c) Do you have other financing?
A factoring line is secured by your accounts receivables. Consequently, you cannot have any financing that is already secured by your invoices. Note that most loans and lines of credit use invoices as collateral.
d) Do you have serious tax or legal issues?
Factoring can be used by companies with tax problems as long as there is a plan to turn the situation around. Companies with legal problems can be considered on a case-by-case basis.
e) Is your company set up properly?
Your company must be set up properly with the government authorities. Additionally, your company must be in good standing with your state’s secretary of state.
Get more information
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