Photo credit: Funding Gate http://goo.gl/7JSF5B What is Factoring?
A financing method in which a business owner sells accounts receivable at a discount to a third-party funding source to raise capital
One of the oldest forms of business financing, factoring is the cash-management tool of choice for many companies. Factoring is very common in certain industries where long receivables are part of the business cycle.
When a small business needs a loan, there are a number of different options available to them. These options depend on the age of the company, credit history, assets and industry. Companies in high growth, high-profit industries, can go after venture capital. Established companies, with good credit, can try for a bank loan. Small businesses who have not been in business long, have average credit and few assets will find it very difficult to get money loaned to them, whether from a bank or from private investors. Even if you have an above credit score, have a record of success you still may not be able to get a small business loan.
Factoring , also called accounts receivable financing or invoice funding is an option. This type of financing requires that a company has customers who typically pay on time and have outstanding invoices. Factoring may not make sense for a company that sends out thousands of small-denomination invoices, because of the service fees a factoring finance company may assess for reviewing each invoice for risk.
Some businesses use factoring to get started. Banks focus on a business’s creditworthiness in considering whether to make a loan, factors look at the financial soundness of a business’s customers. As a result, firms with little to no or scant credit history may be able to sell their invoices
Here’s how it works
In a typical factoring arrangement, your company makes a sale, delivers the product or service and generates an invoice. The factor buys the right to collect on that invoice by agreeing to pay you the invoice's face value less a discount--typically 2 to 6 percent. The factor pays 75 percent to 80 percent of the face value immediately and forwards the remainder (less the discount) when your customer pays. It’s that simple.
Because factors extend credit not to your company but to your customers, they are more concerned about your customers' ability to pay than your company's financial status. That means a company with creditworthy customers may be able to factor even if it can't qualify for a loan.
Pros of Factoring
Doesn't require taking on debt
Factoring doesn't require that a company take on additional debt. While you may have some debt to get started and survive the less debt you have the better. Having debt makes it harder to get loans in the future and also puts a lot of pressure on companies to pay it back. Factoring allows companies to receive funding without the hassle and risk of a loan.
You get the money fast
If your company needs quick, fast, and in a hurry, there are few options better than factoring. Quite often in less than a week, a company can receive up to 95% of their outstanding invoices. For companies with an established relationship with a factor, this time can be as short as two days. This great when you need cash quickly.
Fewer hoops to jump through
When you go to a bank you need to provide proof that you are a good credit risk. You need financial statements, very good credit and an operating history generally two years or more. For factoring generally you don't need to provide this information. While a factor may want background information on the particular company they will be doing business with, the biggest concern will be the credit of your customers. This takes a lot of pressure off your company.
Your company never has to pay back the money
Because the money given out is not a loan, it does not have to be paid back. There are no payments, principal and interest, to be made. The factor is paid back after they collect the invoices.
Factors handle collection duties
Not only will a factor give your company a lump sum of money up-front, they will also handle collection duties.
Cons of Factoring
The service can be costly — several percentage points more than a conventional lender.
The factoring industry is extremely fragmented
There is a a wide variety in the quality of factoring companies. Take care to find someone who has an established track record and won't try to tie you up with additional non-standard requirements that are unduly onerous.
See a review of factoring companies at Top Ten Reviews.com. Factoring Services Review for a comparison of their top ten factoring companies on eight important questions you should ask when looking for a factoring company.
Another approach is to use an online marketplace, such as The Receivables Exchange, where you can post your receivables on a private Web site and have financial institutions bid on them. As a result, you are likely to get more competitive financing rates (there are also no minimum post amounts). The Receivables Exchange says it has access to about $8 billion, though your company must meet the following requirements: two years of operational history, $1.5 million in annual revenue, and no tax liens.
May Damage Your Business’s Reputation
Imagine a factor's collector hammering on one of your customers to collect a receivable. Their only interest is in collecting the invoice they are not concerned with the relationship that you have with your customer. Their motivation is to get the money that is owed regardless. The impact on business and its reputation in this kind of situation is obvious.
Some final Thoughts
Factoring is a short term solution. Most companies factor for two years or less. The factor's role, in the life of a company, is to help them make the transition to traditional financing. Your banker may be able to refer you to a factor. Shop around for someone who understands your industry, can customize a package for you, and has the financial resources you need. So what do you think, will factoring work for you?
A financing method in which a business owner sells accounts receivable at a discount to a third-party funding source to raise capital
One of the oldest forms of business financing, factoring is the cash-management tool of choice for many companies. Factoring is very common in certain industries where long receivables are part of the business cycle.
When a small business needs a loan, there are a number of different options available to them. These options depend on the age of the company, credit history, assets and industry. Companies in high growth, high-profit industries, can go after venture capital. Established companies, with good credit, can try for a bank loan. Small businesses who have not been in business long, have average credit and few assets will find it very difficult to get money loaned to them, whether from a bank or from private investors. Even if you have an above credit score, have a record of success you still may not be able to get a small business loan.
Factoring , also called accounts receivable financing or invoice funding is an option. This type of financing requires that a company has customers who typically pay on time and have outstanding invoices. Factoring may not make sense for a company that sends out thousands of small-denomination invoices, because of the service fees a factoring finance company may assess for reviewing each invoice for risk.
Some businesses use factoring to get started. Banks focus on a business’s creditworthiness in considering whether to make a loan, factors look at the financial soundness of a business’s customers. As a result, firms with little to no or scant credit history may be able to sell their invoices
Here’s how it works
In a typical factoring arrangement, your company makes a sale, delivers the product or service and generates an invoice. The factor buys the right to collect on that invoice by agreeing to pay you the invoice's face value less a discount--typically 2 to 6 percent. The factor pays 75 percent to 80 percent of the face value immediately and forwards the remainder (less the discount) when your customer pays. It’s that simple.
Because factors extend credit not to your company but to your customers, they are more concerned about your customers' ability to pay than your company's financial status. That means a company with creditworthy customers may be able to factor even if it can't qualify for a loan.
Pros of Factoring
Doesn't require taking on debt
Factoring doesn't require that a company take on additional debt. While you may have some debt to get started and survive the less debt you have the better. Having debt makes it harder to get loans in the future and also puts a lot of pressure on companies to pay it back. Factoring allows companies to receive funding without the hassle and risk of a loan.
You get the money fast
If your company needs quick, fast, and in a hurry, there are few options better than factoring. Quite often in less than a week, a company can receive up to 95% of their outstanding invoices. For companies with an established relationship with a factor, this time can be as short as two days. This great when you need cash quickly.
Fewer hoops to jump through
When you go to a bank you need to provide proof that you are a good credit risk. You need financial statements, very good credit and an operating history generally two years or more. For factoring generally you don't need to provide this information. While a factor may want background information on the particular company they will be doing business with, the biggest concern will be the credit of your customers. This takes a lot of pressure off your company.
Your company never has to pay back the money
Because the money given out is not a loan, it does not have to be paid back. There are no payments, principal and interest, to be made. The factor is paid back after they collect the invoices.
Factors handle collection duties
Not only will a factor give your company a lump sum of money up-front, they will also handle collection duties.
Cons of Factoring
The service can be costly — several percentage points more than a conventional lender.
The factoring industry is extremely fragmented
There is a a wide variety in the quality of factoring companies. Take care to find someone who has an established track record and won't try to tie you up with additional non-standard requirements that are unduly onerous.
See a review of factoring companies at Top Ten Reviews.com. Factoring Services Review for a comparison of their top ten factoring companies on eight important questions you should ask when looking for a factoring company.
Another approach is to use an online marketplace, such as The Receivables Exchange, where you can post your receivables on a private Web site and have financial institutions bid on them. As a result, you are likely to get more competitive financing rates (there are also no minimum post amounts). The Receivables Exchange says it has access to about $8 billion, though your company must meet the following requirements: two years of operational history, $1.5 million in annual revenue, and no tax liens.
May Damage Your Business’s Reputation
Imagine a factor's collector hammering on one of your customers to collect a receivable. Their only interest is in collecting the invoice they are not concerned with the relationship that you have with your customer. Their motivation is to get the money that is owed regardless. The impact on business and its reputation in this kind of situation is obvious.
Some final Thoughts
Factoring is a short term solution. Most companies factor for two years or less. The factor's role, in the life of a company, is to help them make the transition to traditional financing. Your banker may be able to refer you to a factor. Shop around for someone who understands your industry, can customize a package for you, and has the financial resources you need. So what do you think, will factoring work for you?
