Factoring For Businesses
Small business owners are constantly on the lookout for various ways to help fund their operations. Attaining finance can be a difficult and lengthy process – the global financial crisis in 2007 has made lenders extremely wary of loaning money to unestablished business owners. This has created a shortage in finance for many small business owners, who in turn miss out on opportunities due to a lack of funding. There are countless different ways that business owners attain credit for their companies, but ‘factoring’ is a low-cost financing solution that is often overlooked. In this article, we will overview the financial concept of ‘factoring’ and how you may be able use it to improve your business’ funding.
What is Factoring?
Factoring is a unique form of finance that allows you to borrow money without taking on any form of debt. Factoring companies will purchase your unfulfilled invoices in advance and provide you with upfront capital for a small fee. For example, you have an order from one of your clients that will result in you being paid $5,000. If you need money now but have yet to be paid by your client, you can sell the rights to your invoice to a factoring company who is then responsible for collecting the invoice.
Many factoring companies will provide you with up to 80% of the capital, and then collect the invoice at a later date – they will return most of this invoice to you and take a small fee for themselves. It’s great for companies who need cash quickly or experience seasonal gaps in cash flow.
There are many advantages to using factoring to help fund your business. We’ve outlined some of these advantages below:
- Low Cost – Factoring is surprisingly low cost; many factoring companies will only charge about 1-3% of your invoice amount to provide you with the upfront capital. They’ll also give you up to 80% of your invoice upfront.
- No Debt – Factoring is not a debt instrument as you are not borrowing money. You are simply selling the rights to an invoice. For this reason, it doesn’t appear as debt on your balance sheet.
- Credit Isn’t a Factor – Because the factoring company is collecting the money from your client, your credit score isn’t a major component in approving your invoice. Factoring companies are more concerned with your client’s ability to pay the debt.
- Quick Access to Capital – Many factoring companies can get capital into your account within 24 hours of initial approval. You should head online to their websites to get pre-approval in order to ensure you can get capital quickly. Traditional forms of finance can be extremely lengthy, meaning if you need capital quickly it may not be possible.
- Cash with No Restrictions – Unlike some forms of finance, you receive cash and don’t have any restrictions on how you can use it.
- Better Respond to Trends – If you have seasonal gaps in cash flow, using factoring can help create a short-term solution to your capital needs.
There are a few disadvantages to using factoring, especially if you’re not using it as a short-term solution. We’ve outlined some of these disadvantages below:
- Not a Long-Term Solution – Because factoring comes in short bursts of cash, it shouldn’t be used as a long-term solution for financing your company. In addition, while costs are low, some traditional business loans are even more affordable. Planning for the future is easier with traditional forms of finance.
- Clients – The other disadvantage of using factoring is that your clients will know about it since the factoring company is collecting your invoice. This can create a negative image for your company if you do it too often, as it appears you are in desperate need of capital.
Types of Businesses That Benefit from Factoring
Factoring is a great option for many businesses across different industries. Certain types of businesses will benefit more from factoring than others. Typically, businesses with large invoices that have rolling payment cycles will benefit the most from factoring. Small businesses that operate in retail or hospitality may not find they have invoices that are worth factoring. The following business types benefit from factoring the most:
- Manufacturing or Production Companies – If you run a business that manufactures or produces bulk materials you most likely have plenty of opportunities to use factoring. Often you won’t be paid by your clients until an order is completely filled, which can create funding problems for you.
- Shipping or Courier Companies – Another industry that benefits from factoring is the freight industry. You may have a contract that runs over an extended period of time, which means you could sell an invoice in advance to get upfront capital.
- Consulting – If you run a consulting business you most likely have contracts that run over a long period of time, sometimes up to a year. This is another example of an industry that you can sell invoices to get capital.
- Wholesale – Much like manufacturing or production companies, wholesalers use factoring for large purchase orders.
Factoring is an awesome way to help finance your company if you don’t have time to apply for traditional forms of finance. It can also help companies who experience seasonal gaps in cash flow. One of the major benefits of using factoring companies is the reduction in red tape that you may face if you try and attain finance through traditional lenders. Getting approved for a traditional business loan or line of credit can take up considerable amounts of time, and may be impossible if you don’t have a good credit history or collateral.
If you feel that you have invoices that take considerable time to fulfill, or if you’re clients are bad about paying their bills on time, you may feel that you are constantly short of cash. This can be a huge problem for businesses that are capital intensive – you need money to fulfill the requests of other clients and maintain your level of operations. Head online and check out various factoring companies and their rates – you should look to work with companies that will give you up to 80% of your invoice upfront.
Jason is a Senior Author for SBL. He has been working with small business owners like you for the past ten years. He graduated with an MBA and began a career as an independent financial consultant for small businesses in his state.