What Factoring is and How it Can Benefit your Small Business
Invoice factoring is a form of alternative lending in which a business owner will sell some or all of his accounts receivable invoices to a factoring company, in exchange for an amount equal to approximately 80% of the face value of those invoices. The ready cash from this transaction can be used for many things, especially to maintain cash flow.
Cash Flow is King
Without steady cash flow, any business would be doomed, because it might not be able to pay for day-to-day expenses, payroll, or inventory needs. Traditional lending institutions like banks cannot approve and process loans in any kind of prompt time frame, because so many approvals are necessary, and because it’s such a heavily regulated industry. With less regulation involved, alternative lenders can react much more quickly to applications from business owners, and supply them with the capital they need.
At the back end of invoice factoring, the factoring company will be responsible for collecting invoice amounts from the business owner’s customers, and once those amounts are collected, the remaining 20% from the invoice amounts would be remitted to the business owner, after the factoring fees were subtracted. This then completes the factoring cycle.
Benefits to Small Businesses
There are more advantages to this kind of arrangement than just greater approval rates and quick approvals though. Because the credit history of the owner is not as important as the payment history of invoiced customers, it is not necessary for an applicant to have perfect credit. This is why approvals can be more frequent, and can be arranged so much faster than with banks.
Then too, any business which factors out a large percentage of its invoices, does not have to maintain a big Accounts Receivable department, nor does it need a large Collections staff. Those two functions are at least partially shifted to the factoring company, so that personnel at the owner’s business can spend the majority of their time performing value-added functions for the company, instead of sending out collection letters.