This blog post will explores in detail whether factoring can work for you. It will also compare factoring with other means of finance.
It is a fact that factoring works for many businesses across many industries. However, it may not work for everyone. For companies that get their payments in full, via cash or credit card, and do not want to extend credit terms to their customers, factoring may not be viable.
For businesses that sell directly to consumers, the traditional factor might not work. However, there are finance companies that offer financial assistance to such companies based on their credit card sales.
Factoring is such is a simple process, compared with traditional financing procedures. You can qualify to use factoring to boost cash flow if you answer ‘yes’ to the following two questions:
- Do you issue invoices to creditworthy customers?
- Do you wait between a couple of weeks to two months?
This is the basic requirement that a factor looks for before working with the business. Apart from this, the factor may have other eligibility criteria, depending on the factor. Some factors cater to specific niches, while others look for invoice volumes.
So are YOU a good candidate for factoring? Apart from the two questions to which you answered in the affirmative, look at the following statements. If these apply to your business, then factoring could work for you:
- You need finance for operating expenses
- You have a growing business
- Your business is less than three years old
- Your business sells to established customers
- Even though your credit rating is not good, your customers are creditworthy
- You often face a cash crunch when it comes to paying for raw materials, payroll expenses, etc.
- You are forced to lose business because you are unable to offer credit terms to customers
- You could do with extra working capital
- You are unable to keep up with timely bill payments due to cash flow problems, resulting in poor credit rating
- If you had cash, you would take advantage of discounts
- You could focus on business if your invoices could be managed
If you can identify with all the statements above, then you cannot afford to ignore factoring.
Now let us compare factoring to the conventional financing options.
When there is a need for finance, businesses generally dip into their own funds. Next, they consider private investors, followed by bank loans, and venture capital. Here is a look at each, in turn, vis-à-vis factoring.
Private Investors vs. Factoring
At the early stages, the business owner will dip into his personal savings and perhaps try to borrow from friends, relatives, and others who are ready to lend or invest. At times, the owner might also have to relinquish equity to private investors in the business in order to raise funds.
As this money also runs out, he might end up gradually losing his share of the business. Debts might build up, along with differences of opinion on operational issues between the owner and investors.
Companies that are trying to survive are perfect candidates for factoring, especially those poised for growth. Because of the way factoring works, the factor and the business grow together, mutually benefiting from the increased volume of accounts receivables. There is no question of losing ownership at any stage.
As a company grows, private investors could be hard to find. With factoring, if the factor is too small to handle the growing business, the services of a larger factor can always be sought. There is also the chance that the growing business’ cash flow may stabilize to such an extent that they may no longer need factoring.
At this stage, banks may be ready to sanction loans because of the business’ good financial standing. However, many businesses prefer to use factoring because of its other advantages. Their factor handles other services like managing accounts receivables, billing, collection, and credit screening, so it is not surprising that a business would always turn to factoring in a cash crisis.