Factoring helps companies that have slow-paying clients. If your company cannot wait 30 to 60 days or more to get paid by clients, factoring comes in handy for that. Factoring your invoices gives the cash that you need to use to run your business. Companies often use the funds from factoring to pay employees and suppliers, build inventory, cover tax expenses, start new projects, get more clients and more.
Why Use Factoring?
The following situations are ways companies can benefit from using factoring.
Improve cash flow from slow paying clients
Once of the most common reasons companies use factoring is to improve cash flow due to slow-paying clients. Slow payments can create persistent cash flow problems for the business. If your company grows fast, these problems can get worse. Factoring their accounts receivable provides companies with immediate funds for their invoices. This funding eliminates the cash flow problem and provides the liquidity to meet payroll and cover other expenses.
New companies, startups, or small companies
No matter what size your company is, cash flow problems can affect you at any size. However, smaller and newer companies do not have the traditional options that are available to larger companies. Factoring can be a great alternative. It is easy to qualify for and can be used by small companies. The main criterion for qualification is the credit quality of your customers. New or small companies with great clients can often get funded.
Getting funded while trying to turn around a company that is trouble is a big challenge for management. The company’s financial statements often do not look good enough to get financing from the bank. Unfortunately, that is the time when they need financing the most.
Receivable factoring can help companies that are gong through a turnaround. It provides a cash flow lifeline that enables the company to improve and become profitable again.
Unable to qualify for a loan/line of credit
Loans and line of credits are the best solution for a company and are the cheapest form of financing available to most companies.
It is difficult to get conventional bank financing. Lenders provide funding only to companies that have a good track record and solid financials. Lenders also stay away from industries they see as risky. Some of these risky industries include transportation, construction, and more.
Receivables factoring is an option for companies that cannot get conventional financing. To qualify you need to have the following:
- Creditworthy commercial clients
- Good invoicing practices
- Good managers
Out of covenant with current lenders
Loan covenants can make it hard to maintain a loan or line of credit even for good companies. Banks often use conservative covenants that do not provide the flexibility some businesses need. Factoring can be a good solution for companies that run into this problem. Most factoring lines have no (or minimal) covenants. Those that do have covenants have flexible rules that can accommodate most situations.
Factoring can be a good solution for companies that run into this problem. Most factoring lines have no (or minimal) covenants. Those that do have covenants have flexible rules that can accommodate most situations.
Most lenders provide financing to companies whose owners have good personal credit. Factoring companies are more lenient with their requirements. They focus more on the quality of the company, rather than on the owners’ credit. Companies whose owners have “less-than-perfect” credit can usually qualify for factoring.
If companies have recent bankruptcies, lenders do not provide funding to them. This is a challenging situation for these companies as funding is critical. Factoring companies can provide funding in many post-bankruptcy scenarios. The company must still meet the requirements for factoring though.
How Does Factoring Work?
Factoring pays you immediately, instead of waiting 30 to 60 days to get paid. The payment enables you to use your funds to run your company. The financing transaction settles when your client pays the invoice in full. Your client still pays on their usual schedule.
There are two installation payments. The first covers 70% to 90% of the invoice. It is deposited in your account as soon as your client gets invoiced. Note that the invoice must be for completed services or a delivered product.
Once your client pays the invoice in full, the factor deposits the second payment in your account. This installment covers the remaining 10% to 30% that was not advanced initially, less the fee.