Factor in Factoring: Why New Small Businesses Should Be Comfortable With Factoring Finance

The first few weeks after a business opens its doors are easily its hardest. However, the same is true for a business’s first few months — and first few years. Before you can iron out the wrinkles in your business plan and obtain a sufficiently large client base, your business is likely to experience a few bumps and bruises on the road to success.

Undoubtedly, the biggest obstacle is low cash flow, which can do much worse than slow a business’s progress; if your cash flow is too low for too long, your business will lose its legs altogether and be forced to close its doors. Thus, during your small business’s beginnings, you should be working your hardest to keep your cash flow healthy — and that will probably mean using factoring finance.

What Is Factoring?

Factoring goes by many different names, including accounts receivable financing, discounting, and invoice financing, but the service is usually identical: A third-party organization called a factor buys your unpaid invoices or accounts receivable at a discount. Your business immediately receives the majority of the unpaid invoice (usually about 80 to 90 percent). Once your client pays their invoice, you receive the rest minus a fee paid to the factor.

Factoring is relatively unique within business finance. Unlike lines of credit or bank loans, you aren’t expected to repay factors the cash you acquire. Rather, factoring is a purchase: Because you have already completed the work your clients requested, the money you gain is rightfully yours, so you have the power to sell it to a factor.

It is important to note that some of the other names for factoring can mean different services. For example, accounts receivable financing can be a type of loan in which your accounts receivable is used as collateral. Discounting is often associated with a different style of factoring, in which clients are not notified of the sale and you might be responsible for collecting payments for the factor. As is true in any business transaction, it is vital you understand the terms before signing any contracts.

Why Is Factoring Good?

Factoring is beneficial for a variety of reasons. For one, your clients are responsible for making the payments they promised, so your business’s credit doesn’t matter to most factors; rather, it is the credit history of your clients that factors use to determine fees and penalties. Thus, businesses with poor credit can still obtain the funding they need to maintain steady cash flow and grow.

For another, factoring is fast. After you develop a relationship with a factor — which typically requires only about a week of investigating business history and negotiating amounts — you can begin receiving advances on your unpaid invoices within one to three days. Conversely, you might be waiting upwards of three months for payment directly from your clients, depending on your net terms. Likewise, loans can take weeks or months to process, as can un-established lines of credit. Factoring is by far the speediest of financing options.

Who Provides Factoring?

A variety of institutions can become invoice factors. Banks and traditional lenders might offer invoice factoring services, but independent factors exist, as well. There is relatively little regulation on factoring, which means factoring providers have nearly free reign on their terms, policies, and practices. Therefore, it is imperative that you find a factor you can trust. To do so, you should look for the following qualities in your factor:

  • Transparency. Your factor should be upfront about rates, fees, and penalties.
  • Decency. Your factor should have a good reputation with previous clients.
  • Security. Your factor should take protection of your information (and your clients’ information) seriously.

When Should You Factor?

Not all businesses are eligible for factoring. Most factors will only consider working with B2B or B2G invoices because businesses and the government are more likely to pay and easier to track down than average consumers. While there are some factors that work with B2C invoices, their programs tend to be much more selective — and expensive. Additionally, factors typically prefer established businesses, those with two or more years of operation. Finally, businesses with legal or tax problems will find it more difficult to secure a factor.

Besides these restrictions, there is hardly a bad time to begin factoring. If you qualify for factoring, you should start leveraging your unpaid invoices as soon as possible, Factoring provides a stable cash flow, on which your business will float comfortably to success — which is something small-business owners should be striving toward.

About the Author

Denny
Hello, I'm Denny Farhan. Interested on Tech, Business, Social media, Internet marketing, and Web development.

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