Factoring, also known as receivables financing, is one way business owners can quickly access cash.
Consistent cash flow is often one of the most stressful issues for business owners. Every company experiences lean months when vendor invoices are due, supplies must be purchased, and salaries need to be paid.
Business owners can quickly access cash through factoring.
Companies that sell their accounts receivable to a factoring company may receive advances between 70% and 90% of the value of an invoice. Once the factoring company receives payment from your customers, you receive the balance owing minus a small set fee.
Could factoring be a solution for your cash-strapped business? Read on to learn more about the pros and cons of this type of asset-financing arrangement.
The benefits of receivables financing
The most attractive benefit of a factoring agreement is quick access to cash. While your customer may not pay an invoice for 30, 60, 90 days or more, some factoring companies can advance funds to you within 24 hours.
Other benefits include:
- Low cost: Factoring can be inexpensive. The set fee for receivables financing is normally between 1% and 4% of the invoice amount.
- Easy access: There’s less paperwork involved in factoring than some traditional forms of financing.
- Increased productivity: Invoicing customers and chasing payments consumes your valuable time. Factoring can free your schedule for moneymaking activities, such as sales and marketing.
The downside of factoring
Although there are pluses to factoring, it's also important to be aware of these negatives:
- Customer perception: When you sell your invoices to a third party, your customers may assume your business is in financial trouble, especially if the factoring company uses aggressive tactics to obtain payment.
- Liability: If your customers don't pay their invoices, you'll still be on the hook for payment to the factoring company.
- Lengthy contracts: It may not be in your company's best interests to enter into a contract that commits your business to using the services of the factoring company for a long period of time. Try to negotiate a short-term contract so you can retain some flexibility with your financing options.
- Fees: In addition to the small set fee, some factoring companies charge a much higher rate of interest on the upfront cash advance. Do the math to ensure receivables financing makes good financial sense before you sign on with a factoring company.
For many businesses, factoring can get them through a cash crunch. Others use factoring regularly as a reliable method of receiving upfront cash on customer invoices.
However you choose to use factoring, be sure to speak with your accountant or trusted financial advisor to get their valued opinion.
Before you take action on any of the information above, we recommend consulting with a qualified business advisor that understands your unique needs and situation for your specific business and/or personal plans.