It is not uncommon for businesses that are facing low cash flow and slow-paying customers to turn to specialized financiers called factoring companies to sell their accounts receivables or invoices. The factor will advance most of the total invoice amount – between 70 and 90 percent – after confirming that clients billed are creditworthy. Once the client pays, the factor deducts a transaction fee and remits the remaining amount to the business.
Advantages of factoring
Businesses prefer this method of financing because it provides an immediate boost to their cash flow, rather than waiting 30-60 days before debtors settle their accounts. With a factor, you can have your money in as little as 1-2 working days.
Factoring is a popular source of cash flow boost for businesses that are just getting started. They are ideal for such businesses, because, while banks consider a business’s creditworthiness, factors consider the creditworthiness of the creditors before advancing the amount. This means that new businesses, which have scanty credit history, can still benefit from selling off their invoices.
Since the factoring company will take care of collections, you as the customer don’t have to think about credit checking, billing and staffing these functions. You also don’t have to spend time following up on delinquent debtors, which can create tension with clients.
Factoring is also ideal for companies that want to expand their reach to regional markets. Factors usually have a lot of experience in dealing with all kinds of buyers and suppliers, which can ease your transition into the international market.
Disadvantages of factoring
The main downside to accounts receivable financing is that its cost is a little more than that f conventional lenders. The reason for this is that factoring first began as a controversial method of financing that was used to financially fragile companies within the clothing industry. The other misconstruction is that only businesses that are not creditworthy enough for banks turn too factors, although today this is far from the truth.
As a matter of fact, billions of dollars’ worth of accounts receivable monies flow through the hands of factors annually, and many of them have decided to specialize their services to particular industries including construction, healthcare and trucking/transport among others.
Some businesses turn to factoring companies as a stop-gap measure for periods of low cash flows. Others yet prefer the hassle-free nature of factors to bank loans, which come with tons of paperwork, red tape and conditions before funds are advanced to the businesses. External investors too may have their own interests which may conflict with the business owner’s interest.
How to make the most out of factors
For factoring to be economical, the business must assess its typical invoicing capability. Factoring works well when you have few creditors with owing large amounts, since service fees take into account the work done in reviewing creditworthiness of each debtor.
With adequate planning, you can make accounts receivable financing work for your business to fulfill both short term and long tern cash flow requirements. Just be sure to use a reputable factor with a proven track record.