Invoice factoring has sparked many heated debates in the business community. This alternative form of financing has had a hard time shaking off its reputation as a “lender of last resort.” Truth be told, there are still plenty of factoring companies that operate this way: charging sky-high prices, forcing desperate business owners into long-term contracts, and aggressively going after their customers for cash. It seems like everyone has a sister whose next door neighbor to her husband’s second cousin had a bad experience with a factoring company, so the lesson is to just stay away from her.
In recent years, many companies have made factoring an essential aspect of their financial planning. There are several reasons why factoring is gaining popularity in the states. The main reason is that cash is king. Even Bloomberg Business reports that factoring is one of the top five alternatives to traditional bank financing.
Businesses use factoring to catch up on accounts payable and capitalize on growth opportunities. Yes, factoring is typically more expensive than a traditional bank line of credit, but the opportunity cost is much higher. Many companies pass up new growth opportunities and turn down the business because they don’t have the cash flow to back it up. Invoice factoring solves this problem.
The way invoice factoring works is quite simple: the proceeds from the factored invoice are sent to the company in two installments. The first installment (usually 90% of the face value of the invoice) is sent to you within 24 hours of submitting the invoice to the factoring company. The second installment, also called a reserve, is remitted to you, minus the factoring fee, when your customer pays the invoice.
Factoring, by design, will grow with your business as your sales grow and will automatically settle if they go cold. The problem with a traditional banking facility is that many businesses don’t have enough collateral for a traditional banking product, and most traditional lending institutions can’t keep up with the rapid growth.
There are very few eligibility requirements to qualify for invoice factoring. The most important requirement is that your transactions are business-to-business sales.
Here are some examples of situations where invoice factoring is used:
- Growing businesses that have trade accounts receivable
- Young companies that are growing but restricted by their cash flow and debt limits
- Companies that continually have overdraft problems
- Any company looking to open a line of credit
- Any company that is in arrears in the payment of the debt
- Any company adverse to debt and wanting to grow on its own assets
- Companies that need to offer flexible conditions to be competitive
- debtors in possession
- IRS Tax Linked Companies
- Any company with bad credit
- seasonal industries
- cash sales
- customer concentrations
- Undercapitalized companies
Companies should do their own due diligence when comparing factoring companies. Many companies choose to use factoring brokers to purchase the deal on their behalf, which offers many advantages. Most factoring brokers can save companies time and money by doing all the legwork for them, and they have the knowledge and influence to obtain and negotiate the best offer available to the company.