How Does Factoring Work?
Are you looking for factoring account recievables and alternative financing options?
So far, we’ve taken a look at how Small Business Administration (SBA) and Revenue Based Financing work. Now, let’s dive into the Factoring as an alternative financing option.
A clever way to unlock some of the cash latent in your business is by selling receivables that your business is owed by third parties. Factoring, or sale of receivables at a discount, is a great way to finance unforeseen cash flow shortages. With factoring, an alternative lender will instantly give you capital by purchasing the invoices of your company at a defined percentage.
Factoring gives you two advantages:
- Immediate cash in hand to solve your cash flow needs
- Time and resources freed up from chasing invoice payments
This is an especially good alternative financing route for companies that are owed large sums from vendors or customers.
Among other reasons, factoring is most suited for your business when you want to expand or renovate, purchase equipment, upgrade inventory, or ensuring timely payroll.
What you should know about Factoring
- Factoring can be a relatively cheaper financing option compared to revenue-based financing. This is especially true if you have slow paying customers or long-term remittances.
- A factoring fee may be assessed based on the cost of the entire invoice or even the amount you’ve taken as an advance. In fact, most factors give an advance between 70% to 90% of the invoice and your factor rate may increase on a weekly, bi-weekly or a monthly basis. Typically, a small business may pay 2% to 6% in factoring fees. Therefore, it is advisable to determine ahead of time that your company’s profits are able to cover the cost of financing via factoring.
- The alternative lender providing factoring services will inform your clients of the business relationship between your company and the factoring company. This is done to ensure that your invoices are correct and that the clients are satisfied with you.
- Your company is not required to provide collateral.
- Factoring is available to businesses based on their receivables so credit history is not considered for this type of financing.
Factoring may be a good option when:
- You have large receivable invoices from one or two vendors or customers.
- Your credit history will not allow other financing options to be viable.
- You have already taken one or more merchant cash advances.
Factoring may not be an option when:
- Your relationship with the vendor/customer that owes you funds is in danger of being negatively impacted due to sale of the receivable.
- The receivables are through multiple vendors or customers.
Remember, it is advisable to use factoring for an emergency cash injection. When you’ve chosen a company to be your financing provider, ensure you read the fine print to avoid surprises later. For instance, your factoring agreement may be subject to additional fees like a service fee, lockbox fee, credit check fee and more.