Small businesses do not have the same financing options as large businesses. But small businesses can use invoice factoring as a financing resource that helps them in two ways. A factoring company can provide a business cash advance based on future sales, and it can release the locked-in money by purchasing invoices.
The following information explains how five important factoring measures can improve cash flow:
Days Sales Outstanding (DSO) is a metric used by small businesses to measure the time lost between a sale and revenue collection. The DSO is learned by dividing accounts receivable by credit sales, then multiplying by the number of days. A high DSO number reflects more wasted time, which can negatively affect cash flow. It can also alert you that the billing and collection processes need to be improved.
Average collection period
Another useful measure is the number of days in the average collection period, which is obtained by dividing the product of the days multiplied by the average accounts receivable amount divided by the net sales on credit during the period. Keeping this number low is important for most small businesses because it lets them know how many new customers and large orders it may take.
Revenues from working capital
This measure of working capital turnover is found by dividing sales by working capital. It reveals how much working capital has been depleted, which is useful in knowing how well your organization is using working capital for sales generation. High numbers represent high sales relative to the amount of capital used to pay for operations and inventory.
To find out how well your business is extending credit to your customers and how well it is collecting debt, divide your net sales on credit by the average accounts receivable amount. The result will be the rotation of accounts receivable, which will help you decide whether or not to extend favorable terms that attract new customers.
The churn rate is an important metric because it tells you how many customers you have lost over a certain number of days, which might reflect customer satisfaction.