The Pros and Cons of Invoice Factoring in Tech Services Cashflow Management

Cash flow management can be one of the most painful subjects for freelancers and entrepreneurs in a small business, and it's a subject that's often poorly understood. Business owners often lack the language to have a productive conversation around the topic of cash flow finance, yet it's vital to long-term sustainability. It's not uncommon for tech companies to have significant revenue and terrible cash flow management.

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Invoice factoring companies can seem very attractive for small business owners facing unpaid invoices and cash flow problems. But is trading your invoices for immediate cash the best solution for your financing needs? The simple answer is, perhaps, but the equation is often complicated. But before we dive into the pros and cons of invoice factoring, let's first discuss common cashflow issues and effective ways to mitigate them.

Five Common Business Cash Flow Challenges:

1. Late-paying customers and outstanding invoices
2. Sick employees
3. New employee training time
4. Spending valuable time and working capital chasing what might go wrong
5. Bookkeeping errors

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As a proactive entrepreneur, there's a temptation to solve each of these cash flow problems personally. But for business owners in the first three years of business, trying to prevent these problems with your own time and energy versus having a solid cash management game plan in place is usually counterproductive. A healthy cash flow allows you to manage those same problems with extra money in the bank—and it's the difference between night and day when it comes down to what you're able to do when running a company. 

Are You Charging Enough?

There's a lot of merit to staying out of an overwhelmed state for a business owner and staying in the groove of being able to operate your business' momentum. Solid leadership looks like focusing on what's going right and maximizing that instead of the ten things that are mediocre. Getting your business in a cash position with so much margin that you can afford employee sickness and training times, late payments, and bookkeeping errors. All of these mistakes add up and can easily bankrupt a business. 

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There's a single way to get ahead of that: charging enough and maintaining low overhead. 

If three things go wrong in a single week for most small businesses, they're in trouble. There's a certain tension in facing one fire at a time, knowing you can't handle two or three at once. The business owner ends up serving that one issue for months or years when raising prices could have solved the same problem. 

If, for example, in-house training isn't good enough, what if raising prices would allow a company to hire someone better? Or what if the cost of required courses for new employees to take before they start with you was covered up-front? There are a lot of issues that cash fixes if properly applied, but when you're in a competitive marketplace, the temptation is to win on service, price, and uniqueness. 

Know When to Outsource

Being well-rounded is necessary in the technical services space–no business operator likes delivering bad news to clients. Having the cash in your bank account allows you to say, "We're not that good at that, but we can farm it out to someone who is," takes your no, or your, "We'll do that, but we don't know how yet," and turns it into a strong yes. It keeps you going. A healthy cash flow allows business owners to use capital to pay outside vendors to do things they're not good at.

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I run a software services company and, for us, SEO has a limited depth in our company. We have some incredible contract partners that we pull in when we need the next level of SEO. I can't afford to pay someone in-house to keep up with the latest SEO strategies in 2022, and it changes so fast that the training I paid for last year is now void. It would be best if you had someone whose full-time focus is to be a true expert, and they need to be better than average in their space. 

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I have dozens of friends running small businesses with under 50 employees, and I know what stresses the average operator or entrepreneur startup leader. They are all very capable of doing many things, which is why they're in the leadership positions they're in. But entrepreneurs must realize that they simply shouldn't do it all. Establishing basic boundaries when it comes to what's right outside of your company's skill set, and having the available cash to outsource those tasks, can make or break the long-term viability of a company.

Scaling Cashflow Management

If I'm running a business that makes $500,000 a month or $50,000 a month and I'm spending ninety percent of that, we all know there's a vast scale difference. If I only have a $10,000 buffer, I should hold onto it and put it into savings. I'm going to have $10,000 mistakes come up this year, and I will need that buffer. But if I have a $50,000 margin, I probably have enough cash to buy the required expertise if I get in a pickle. I can purchase redundancy if a project needs redundancy. I can buy accelerated training or marketing. Perhaps we'll need to invest in a marketing push or a salesman. Even though both companies run on ninety percent margins, the cash flow management looks very different.

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What's important isn't knowing your margins by percentage; it's knowing your freed-up cash that's stabilized and predictable. It's important to ask, is it reasonable to operate with enough money to have choices next month or next quarter when you hit a speed bump? Can speed bumps be solved by deploying a trusted team member with freed-up cash versus the business owner having to take their eyes off the road and be distracted? That shift in focus can be costly when operators find themselves driving a significant endeavor, and they're likely to wreck when they've taken their eyes off of what they're good at.

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Having a network of contractors you're talking to that helps you solve those problems requires margin. Building a network that acts as an extension of your company or your product takes time. You have to buy time with money, which comes down to deploying capital wisely.

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Let's say you invent something, and you've ordered this product that people really like, and you're shipping it out to pre-ordered customers. If one thing goes wrong in that first run, your product reviews will tank. If you sell a universal remote control that your customers have been dying for, yet one crucial button doesn't quite work, you've wasted $100K on manufacturing this sweet universal remote. Now all of your reviews and all of your customer faith have tanked. It doesn't matter how beautifully you've nailed the packaging or how amazing your video is–you're tanked. Now you need another $100K to fix that. And then you need time. Now, if you have $250K available, you can fix what's gone wrong, and your chances of being business five years from now are so much higher. 

Testing the Price Ceiling

The hardest lesson in my career has been recognizing that I can fix many things myself, but I need staying power to do that. To be sustainable as a business leader, I have to buy myself time. I can't be the solution to every unknown. I have to have me plus cash. I have to be able to say, "Maybe I COULD solve that problem, but I'm definitely not the BEST person to do that." If I have some cash on hand, I can hire or manage the right person to solve that problem; that will allow me to thrive for a couple of decades in a business. 

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You need to be able to absorb the unknowns. That means two things:

1) Charging enough to your customers 

2) Testing the ceilings of your rates

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We're currently priced in the lower middle in our industry, and I know that that's not healthy enough. I know that in 2022 I need to do a meaningful price increase because of the unknowns we're navigating with COVID, technology demands, and increasingly competitive hiring. I'm nervous about what our customers will say. It will add more pressure, but that's mostly a facade. I haven't yet asked them or tested rate increases. In some sense, it doesn't matter because the true cost of business does incorporate the future. You have to know, I'm going to run this business for another year, and some things will go wrong; I have to have the cash flow for that now. 

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Testing the price ceiling is the hardest thing to overcome psychologically. Detaching yourself from the ego of your value proposition and saying, "We're going to see what the market is willing to pay. If there's a ceiling on it that makes this business unsustainable, then I'm going to sell a different product or service. The market has spoken." But if you don't know that the market has spoken, then you're not testing enough.

Is Lending Part of a Healthy Business?

In my opinion, lending is always a part of a healthy growing business. However, taking on debt in a company that's still very much in the testing phase isn't always the best choice. Don't try to operate with debt on something unproven.

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The health of any company must be defined as a sustainable growing business. If you know your business well, you know there are ups and downs. Lending decisions come down to basic margin theory. If I can only make nine dollars from a borrowed $100K, then I'm probably not running a good business, or I'm the wrong person to run it, or my customers are the wrong customers. 

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It's crucial to be in an industry where you know there are plenty of other customers out there, and given another twenty-four months, you'll out-compete a nine percent interest rate because you have so many tools at your disposal. You can hire, create, and upsell to existing consumers–there are many different levers to choose from. But, yes, I do think that business loans are an important part of operating a business. 

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With COVID, the government made available some very cheap money for most types of businesses. I believe that most sustainable companies are making good use of that. If we're talking about borrowing from credit cards, on the other hand, I see that as bad debt in nearly every case. Twenty-five percent interest is going to be challenging to fight up against. Invoice financing companies may provide a solution for technical services companies who need quick cash.