PrintOdds are you'll experience cash-flow problems at some point during the life of your business. Some companies face shortages during the startup phase, while others don't have the cash they need to grow their businesses and take them to the next level. There are many things you can do to improve your cash flow, such as focusing on collections efforts or getting professional assistance with budgeting and forecasting. But when these options don't pan out, some companies turn to factoring.
Factoring is the practice of selling accounts receivables (invoices) in exchange for instant cash. Factoring is a relatively quick and easy solution for cash-strapped companies; however, like any type of financing, it comes with a price. The factor - a factoring company, a bank or a commercial financing company - charges a fee for its services (keep reading to find out how much), which is why factoring makes a better short-term than long-term solution.
How Factoring Works
A factor will want to examine your invoices and check the creditworthiness of your customers, so be prepared to open your books. Factoring companies care more about your customers' paying habits than yours, but you should be prepared to show the factor a current financial statement, an accounts receivable aging report, a certificate of incorporation or partnership agreement, proof of insurance, invoices and other business documents. Since the factor shoulders the responsibility for collecting your receivables, it wants to make sure your customers pay their invoices in a timely fashion.
Once you and the factor determine which invoices it will buy, the factor will typically pay you an advance; for example, it might pay you 80 percent of the total amount of your invoices and then reimburse you the other 20 percent when your customers pay their invoices, minus its fee. Factors' fees vary depending on the size of your invoices, your customers' creditworthiness and the number of days in your collection cycle. But you should expect to pay anywhere from 3 percent to 7 percent or more of the total the factor collects.
Look Before You Leap
Before you consider factoring as a way to get cash for your business, consider the pluses and minuses. Factoring can be a viable solution, especially if you need cash in a hurry. Once a factor receives your application and reviews your invoices, you can receive payment in as little as a week. But factoring also has a few downsides:
- Customers who see a factor's name on your invoice might consider it a sign that your business is unstable or going under.
- A factor can turn down invoices of customers it deems uncreditworthy, or it can stop paying you on accounts that remain past due. So if you have a lot of deadbeat customers, factoring probably isn't a good solution.
- You'll probably discover that the cost of factoring is higher than the cost of a short-term loan. That's why many companies turn to factoring as a last resort when they can't get bank loans or lines of credit.
- A factor might not want to work with you if you have a small amount of receivables. Many factoring companies prefer to do business with companies that have $10,000 or more in monthly invoices.
As with any decision, it's important to do your research and explore all your options. Talk to your banker, accountant or a business consultant before you make any financing decisions.
