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What is accounts receivable financing? Just a fancy word to replace the nasty “F” word, factoring?! Why on earth would a company want to factor? Well simple, to speed up their cash flow. What if I told you, not all companies that factor are bad? Would you believe me? It’s true, not all companies that factor are in financial destress. Simply, these companies want to control their cash flow and not wait 30, 60 even 90 days to receive payment for services rendered.
Before we dig deep into factoring, what is Factoring? Factoring offers businesses an alternative source of working capital, in which a third party (factor) advances on a business’s accounts receivables (invoices) for immediate cash. It is a method to bridge a working capital cash flow gap.
A factoring companies’ mission is to provide a cash flow vehicle for early stage or transitional companies leading them to a traditional bank line once the client is quote on quote “bankable”.
“Factoring is not a loan, we are using your invoices, your completed work by advancing you a portion of the invoice while taking a small fee once the invoice pays through”
Now that we understand the concept of factoring, what exactly are the steps from start to finish if you want to factor a receivable. The cash flow process, Factoring Client issues invoice to its customer, invoice for completed service/ shipped product is sold to the factoring company. Factoring company advances a percentage of the total invoice to the client, cash for the sale of the invoice is used for business purposes, operating expense, or cash surplus on the balance sheet. Customer pays through factoring clients’ lockbox, client receives the remaining reserves less fees.
Okay, so now we know the process of factoring, but why would a company decide to factor verses having a bank loan/line? The most common reason a client would decide to factor could be the following: Early-Stage Business, Historical Financial Challenges, Tight Cash Flow, Rapid Growth or Customer Concentration. Remember, banks get nervous when you are working with one or two large customers that make up 50%-100% of your accounts receivable. If you lose that contract, what is the assurance for the bank that you will pay back the loan/line? Factoring is not a loan, we are using your invoices, your completed work by advancing you a portion of the invoice while taking a small fee once the invoice pays through. Remember, Factoring is short term cash, not debt. Unlike equity, no ownership dilution or loss of control.
Factoring isn’t always the best option for some businesses, but other businesses, it is the better option. Have you ever wondered why your larger clients ask for a discount if they pay early? Supply-Chain financing is another form of alternative financing. Now granted, factoring is typically more expensive than traditional financing but if you could offset the cost, would you? If your supplier would offer you a discount if you could pay them sooner, would you take it? So, before you get scared of the “F” word, ask yourself, if I am having trouble obtaining bank financing, and I really do not want to give up equity, factoring could be a great alternative to take your business to the next level.