The pace of change in today’s business environment is undeniably staggering. growth of electronic commerce; changes in business structures; evolving relationships; changes in financing agreements; access to capital and its sources. All occurring at increasingly exponential rates. Fast. The fact that there is more computing power in the average laptop today than it took to put a man on the moon should illustrate just how quickly things change, and whether in top management or the owner of a business needs to keep up.

In particular, you need to keep abreast of changes in your competitive environment and be fully aware of the mechanisms that will allow for a quick enough response to keep you in the game. This article will look at one such mechanism, access to capital, and through that, free cash flow. In doing so, we’ll use an intuitive framework, sprinkled with some economics. Because? Intuitive analysis is ideal for answering specific affairs; in this case, ‘What will best enable my company to manage rapidly changing competitive economic conditions and stay in the game?’ And I’ll use economics by Steven Levitt, America’s foremost under-40 economist, who along with Stephen Dubner believes that ‘if morality represents how we would like the world to work, then economics represents how it really works.’

By speaking of specific anchor points, strategic issues affecting the problem of access to capital can be explored and initiatives can be developed to enable a timely solution. In short, it is the fastest and most accurate way to answer the question you are facing, because it is easier to understand and you don’t get bogged down in superfluous and unnecessary analysis.

One of the anchor points in contemporary business is access to capital, especially when it helps keep cash flow free. In many ways they are the same, the difference being that access to capital is a necessary precursor to free cash flow (you can’t use it until you have it). And everyone needs it. Payroll, materials, overhead, and debtors who take 45-120 days to pay off their accounts, using your business as a substitute line of credit.

Access to capital becomes an even bigger issue in the business environment described above, where speed to market and the ability to “gear up” (increase production) are crucial to meeting ever-shrinking lead times. Many of us have experienced the euphoria of receiving a big tender, something that will fill the order book for the next six months, followed immediately by the hangover that comes from realizing that the company will have a hard time financing the project based on the prices. existing resources and cash flow forecast.

Small and medium-sized businesses face particular problems when it comes to cash flow and access to capital to finance growing operations, to the point where lack of access is a problem that can threaten the continuity of operations, even in a competitive market. on the rise Balance sheets take time to build, and it is against this security that banks will lend.

Developing initiatives to address this problem involves looking at some existing options and making a comparison, reaching the decision that best allows a solution to the problem in question. In this case, a comparison of bank financing with invoice factoring provides insight into possible solutions to the access to capital/cash flow problem.

Everyday economics can inform this comparison, particularly the study of incentives: how people get what they want or need, especially when other people want or need the same thing. Let’s start with the banks.

Bank loan requirements are invasive and restrictive. They often create the feeling that you have to ‘strip everything’ to borrow a penny. Naturally, they would dispute this statement, but back to the incentives: what is their incentive to lend you money? To get a return on your efforts. Certainly nothing less than this, and these days they also use loans as leverage to gain most of their wallet from their rivals, trying to have you as a customer for life, ‘growing with you and your business’. When you add the fact that there is a surplus of people who require credit in the market, they can afford to be picky and do the economically rational thing: be risk averse. Risk aversion drives the mortgage a bank places on your home to ensure they get paid, and it’s what drives them to lend against strong balance sheets. They examine balance sheets in an accounting manner, weighing tangible, realizable, and liquid assets like cash and real estate, apply a formula, and lend according to how the results compare to their risk matrix. Your continued success is in their interest only to the extent that it enables you to pay off (and ultimately pay off) your debt, generating a continuing margin on your investment.

An overly simplistic description, the aim is to illustrate that all of this takes time and is structured around strong regulatory and evaluation constraints. A lot of time and a lot of influential rules. First, for you to build your balance sheet, and second, for it to be evaluated to the point where your banker can open or expand your line of credit. During that time, the window of opportunity to finance that big project, expansion of manufacturing, or operations in a rising market quickly passes, leaving you out of pocket for the application fee and, if successful, to service some remaining debt. greater than you may not need.

When it comes to billing factors, the incentives may seem the same, but the way they see getting your return is slightly different. While banks rely on their acumen to accurately predict your ability to repay a debt, billing factors rely on your abilities to accurately assess the repayment ability of your customer base. Lower perceived risk aversion with billing factors plays little role, but it’s how the factor views the overall situation that is different from traditional lending. For starters, the factors recognize your accounts receivable as assets, just like the bank. The difference is that a billing factor views your accounts receivable as a rapidly realizable asset and is prepared to purchase the rights (and risks) to collect your outstanding invoices.

Put another way, in economic terms, the invoice factor recognizes your receivables as assets with future value in terms of cash flow, and as long as your assessment of your customers is favourable, they are prepared to “provide a market” cash for those assets. However, this ‘market’ is closed with their transaction by selling them the invoice; there is no secondary market like junk bonds or other derivatives.

Access to capital through factors is more expensive than traditional loans, and this is due to the risk premium attached not to you, but to your customer base. This is not surprising, and you and I would probably do the same. Going back to economics and our study of incentives, a rational person requires a premium for each additional unit of risk he takes. A higher incentive for higher perceived risk. In the case of factoring, the premium is higher than equivalent bank loan rates, as the risks are considered slightly higher when the collateral is not real estate, but a first position claim on all your receivables. . Your risk exposure is less than collecting the receivables yourself (billing factors are great in business): the higher fee the factor charges compared to the bank is simply the premium you have to pay to reduce that exposure.

The difference that the factors provide is the speed of access to capital and what happens when you default. If you don’t pay the bank loan, you could lose your business, even the family home. Factoring is not as drastic, although the sums of money involved are invariably smaller. There are two types of factoring products available, recourse and non-recourse, and again, the difference comes down to the assumption of risk and the premium requested to bear the risk of non-payment of an invoice. With recourse factoring, you remain responsible for your customer’s non-payment, and with non-recourse factoring, the factor bears the risk up to a certain point and at a higher premium.

In summary, there are advantages and disadvantages to both traditional loans and factoring. These are volatile economic times, and having been burned multiple times during the boom times of the previous two decades, banks are much more risk averse, keeping a tight rein on their credit standards. So, in light of this information, we return to our problem, seeking to answer the question: “Which of these approaches best offers the flexibility I need to allow myself the opportunity to thrive in a rapidly changing business environment?”

For many businesses, the answer lies in invoice factoring, which generates more than $1 trillion in credit across the continental United States. As with all business situations, there are caveats, or otherwise described, arrangements that, if not continually monitored, can become a comfortable security blanket that could actually be slowly suffocating you.

Continuous access to cash flow through factoring is easy to get used to. It’s also easy to take comfort in the knowledge that you’re backed by a massive publicly traded institution like your bank. Management and owners of small and medium-sized businesses must continually remind themselves that the study of incentives works for them too. Constant review of your cash flow and equity financing arrangements is essential to ensure that the deal you end up with is the best deal for your company and not for others. It’s about getting what you want or need, especially when other people want or need the same thing.