Q: What is factoring?
Factoring is a financial service that provides businesses the opportunity to raise working capital and increase their cash flow without incurring debt. Companies sell their invoices (accounts receivable) to the factoring company at a discount. The factoring company in turn collects on the invoices.
Factoring has been used by businesses since ancient times, but has become more popular since the 1990s as a way to bridge the gap between the time a company issues an invoice to a customer and the time that the customer pays that invoice. Factoring is an increasingly popular alternative to traditional bank loans and high-interest merchant cash advances.
Q: Who uses factoring?
Most businesses that sell services or goods to other companies are eligible to factor their invoices. Applicants for factoring services are usually evaluated on their customers’ creditworthiness, rather than their own credit score or collateral, so a short or negative credit history typically does not disqualify an applicant.
Small, medium-sized, and large companies use factoring. Many businesses in the manufacturing, trucking, staffing, wholesale and retail, and oil industries work with factoring companies. Many companies that sell services or goods to governmental institutions also frequently depend on factoring programs to maintain their cash flow.
Q: How can factoring help a business?
Working with a factoring company can help a business in many ways, but the most important is getting paid quickly for work completed. When a business factors its invoices, it receives what it is owed right away, minus a small factoring fee, rather than having to wait 30, 60, or even 90 days for payment.
A factoring company does not typically place any restrictions on the use of the money that is advanced to a business. Some factoring clients use the money to grow their businesses, such as hiring new staff, buying new equipment, or expanding sales and marketing efforts to acquire more customers. Others use the funds to keep up with operating expenses and stabilize cash flow.
Q: How is factoring different from a bank loan?
Invoice factoring provides an affordable, convenient alternative to traditional loans from banks or other lending institutions and features a number of important differences. First, you do not incur debt: you are simply receiving an advance on work you have already completed. You are not projecting that you will earn some now-unknown amount in the future and you are not promising that you will pay back the loan, with interest, with those projected earnings.
In most cases, you will be approved more quickly for your first funding from a factoring company. With factoring, you have no limit on how much financing you can receive as the factoring process is based on your outstanding accounts receivable, not your net worth. Because factoring companies evaluate your customers’ creditworthiness rather than your own, you can be approved right away for advances regardless of your own business background, credit score or collateral.
Q: How does factoring affect the factoring client’s customers?
Factoring has almost no effect on the customers of a business that has chosen to work with a factoring company. The main difference is that once the client sells its invoices to a factoring company, the factoring company collects on those invoices directly from the customers. Customers receive letters advising them to remit their payments on those invoices directly to the factoring company.
Reliable factoring companies have well trained and courteous collections professionals who treat clients’ customers with the same courtesy and respect that they treat their own clients. When customers know that their vendor or supplier is working with a factoring company, they also know that the vendor is now well-funded, with enough financial resources to complete the agreed-upon job or project. Factoring can reassure customers that their vendor can pay for supplies, staff, fuel, or other expenses and can deliver on their commitments to customers.