Factoring is an innovative but often-overlooked creative strategy to maintain a dependable level of cash flow in their business.
What is factoring?
Factoring is a form of asset-based lending. It’s a type of financing that allows businesses to get immediate access to cash based on the value of their open invoices. They do this by selling their accounts receivables.
Companies that offer factoring services essentially buy a business’ open invoices. The benefit is that the business doesn’t need to wait to get paid by their customer to access cash. Instead, they receive it in two payments. One immediately and one later.
First is the advance, which includes a percentage of the invoice’s value paid upfront. The amount varies but can be up to 80% of the open invoice, depending on the industry and the creditworthiness of the invoiced customer.
Second, when the customer pays the invoice, the factoring company pays the business the balance on the invoice, minus a finance fee. Then, the invoice is considered paid.
Why do businesses use factoring?
Factoring gives businesses earlier access to the income they have already earned but not been paid from clients or customers. It’s a way of increasing their working capital quickly. Most often, businesses use factoring to address temporary cash flow shortages. It enables them to pay their expenses and keep their business running smoothly.
Factoring is considered a lower risk for the lender. Therefore, it often offers more competitive rates than a more traditional loan. There is no question about how or if the business will earn the money to pay the loan back. They have already earned it and are only awaiting receipt of it.
Upon acceptance, with factoring, a business can often receive funds within 24 hours.
How does factoring help businesses?
Some industries require or expect certain businesses to offer clients or customers payment terms of Net 30, 45, or even 90 days. This creates a substantial lag time between when a product is delivered, and any payment is received for it.
For new or growing businesses, this can create a cash flow challenge. They likely have had to spend money on salaries and/or materials to provide the service or create the product they have issued an invoice for. This means their business will have incurred expenses upfront but must wait to receive the income to pay for them.
For a growing business, a great demand for services or products may require more cash to fulfill them than the company has available. Factoring enables a business to access the cash they need to meet demand instead of turning away customers or delaying sales.
For this reason, factoring can help a business grow faster.
Is purchase order factoring right for my businesses?
Factoring can be the ideal tool to help small to mid-sized or new businesses that haven’t yet accumulated significant working capital. Since approval for factoring is contingent on the ability of the client or customer to pay the invoice and not on the credit rating of the business itself, it is accessible even for those businesses without an extensive credit history.
If a company has unpaid invoices with extended terms from well-established businesses or government agencies and needs immediate cash, factoring can provide just the solution it needs. The business owner only needs to be sure that the invoice does not have any liens or encumbrances against it and that the business is not currently dealing with unaddressed tax or legal issues.
It’s important for business owners to understand the power and advantages factoring can provide. It can help fill the gap in cash flow and do it quickly.
Factoring helps business owners leverage the value of their accounts receivable. It’s faster than a loan and definitely a far smarter option than racking up large credit card bills with high-interest rates while awaiting payment. Factoring helps keep businesses running smoothly, and most importantly, growing at their top speed. In some cases, it’s the perfect solution to managing cash flow and one that more business owners should consider.