Why Would a Small Business Use Factoring Services?
Why SMBs Use Factoring Companies for Funding Working Capital and Increasing Cash Flow
When your small business or mid-sized company needs working capital with flexibility or fast financing, factoring companies provide needed cash flow. A factoring company takes on the burden of waiting for accounts receivable invoice payments and in return provides your business with a timely cash advance. This receivable financing, also known as invoice factoring, is a flexible and fast financing alternative to traditional bank business loans. Factoring is when an accounts receivable invoice is essentially sold at a discount by your business to a factoring company, referred to as a “factor.” Banks traditionally require a burdensome approval process to loan money. That loan will bear interest at market-driven interest rates and results in debt for a business. Yet, a reputable factor starts approval within 24 hours and provides funding same-day or up to ten days for a new client without subjecting your business to the volatility of banking interest rates and avoiding debt on your company’s books.
How do Companies Benefit from Long-Term Factoring?
Companies that often benefit from long-term factoring financing include those that usually face business scenarios, such as:
- funding required to maintain substantial inventory or materials for production,
- long-duration sales cycles,
- volatile cash flow,
- slow paying customers, such as, large corporate buyers or government agencies, or
- seasonal sales.
Factoring fuels your business growth when your company is presented with opportunities, such as:
- unanticipated or urgent customer demand for products or services,
- timely opportunities to expand into emerging markets,
- innovations that present a chance to invest in new technology and equipment, and
- options to expand offices, production workspace, or inventory warehousing.
When a company faces short-term risk jeopardizing business operations due to a cash flow crunch, factoring is a remedy for:
- operating losses,
- payroll funding needs,
- maxed out lines of credit, or
- bank turn-downs.
Factoring also supports the strength of your company with cash liquidity when your business goals are to:
- obtain immediate cash to finance any business use without creating debt,
- startup a new venture or line of business with no financial track record,
- infuse cash into your business as if using it as a bridge loan,
- improve your company’s business credit rating,
- benefit from trade discounts,
- make timely tax payments, or
- handle State tax or Federal tax liens.
How does a Factoring ‘Loan’ Compare to Bank Loans?
A factoring company with a long history and robust resources can provide an approval process that gets started within 24 hours. An alternative to the often lengthy and trying vetting process of applying for traditional bank financing, a seasoned and resourceful factor is nimble and well-positioned to provide funding with urgency. Due diligence for factoring financing focuses on the fiscal health of your customers whereas banks analyze and weigh pros and cons of a company’s assets, net value, and creditworthiness. The best news of all is that funding provided by a reputable factoring company happens within three to ten business days of a signed agreement for a new client. An existing client can be funded as fast as the same day.
A key advantage to factoring is having money in-hand fast and efficiently from the point of sending an invoice to the factor. Whereas a business usually waits 30, 60, or even 90 days for a customer payment.
How Factoring Provides Security for Business Finances and Accounts Receivable Management
A factor typically advances 70% to 90% of the amount of an invoice to your business upon confirmation of your billed customer’s credit-worthiness. Once your customer pays an invoice in full, the factor then pays your company the balance due for the invoice after first retaining any costs for the transaction.
To benefit from the advantages of receivables financing, the factoring agreement between your company and the factor will of course define terms and incur charges, such as:
- the rate at which funds will be advanced to your company against the net amount of your customer’s invoice,
- a predetermined maximum amount of funds available to be advanced, also known as, the initial factoring line,
- factoring fees, sometimes referred to as a discount fee, based on a percentage rate of the value of the factored accounts receivable and variable according to invoice terms,
- any necessary terms, charges and fees to mitigate risks and cover costs for administration and management of the factoring arrangement, and
- length of duration of the factoring arrangement.
A factoring agreement with a long-standing, credible factoring company provides your business many valuable benefits like:
- maintenance of accounts (ledgering) related to factored receivables,
- collection of receivables,
- protection of your company against default by account debtors with a type of factoring called “non-recourse,” meaning the factor takes on the risk of nonpayment for invoices due to the account debtor’s financial inability to pay, and
- accounts receivable credit protection against account debtor bankruptcy.
How Factoring Works Has Many Advantages for Small and Midsize Companies
When your business turns to a factor for financing, your company benefits from:
- flexibility for financing company operations,
- a fast and efficient funding alternative to bank loans, and
- the security for business finances and accounts receivable management provided for by your factoring arrangement.