Going to the bank to get a loan for your growing business seems about as ordinary as Monday night football and summertime barbecues. Yet in this changing economic landscape where attaining a business loan isn’t as simple as it used to be, what other options are available to business owners?
Factoring receivables, also known as invoice factoring or financing, is a way small to medium sized businesses can get reoccurring capital for their companies without the aggravations of applying for a loan. To be clear, factoring is not a loan; you are not putting down collateral to borrow a set amount of money from a bank to be paid back later at a pre-determined interest rate. There is no lengthy application process, no credit check, and no several weeks waiting period to find out if you qualify.
Instead account receivables factoring is a way your business can collect an advance for its existing receivables or invoices. That is, rather than waiting 30-days or more to collect payment from customers, you sell your invoices to invoice factoring companies so you can collect the bulk of invoice payment – 70 to 92 percent or more – in a matter of days. To qualify, your customers must have good or excellent credit scores. Your creditworthiness is not used when determining factoring receivables’ worthiness.
What Businesses Qualify for Invoice Factoring?
The ideal candidates for account receivables factoring are those small to medium sized businesses that have large reputable corporations or government agencies as customers. So if you manufacture, sell, or otherwise produce goods to a big-name firm in transportation, freight, telecom, manufacturing, technology, oil & gas, construction and more, you are the type of company that invoice factoring was made for.
Recognizing the usefulness and value of account receivables factoring in recent years, many other industries have gotten on board and now use factoring invoices as their go-to commercial financing option. These industries include: staffing, trucking / transportation, service providers, healthcare and medical, startups and more. By using this financial tool, businesses can solve cash flow issues without going through the process of applying for a loan. For instance, truckers can ease the pain of financing their loads and companies can reduce the challenges of meeting payroll.
Advantages of Invoice Factoring
Because factoring receivables enables you to get capital quickly from your invoices, you are in a position to avoid cash flow slowdowns and have steady working capital. This in turn allows you to have capital at the ready to: expand your business, move into a new market, increase production, hire a large number of staff at once to meet growth demands, cover existing bills without worry, purchase or lease new equipment and more.
Due to the fact that factoring invoices moves at a fast pace, many businesses see factoring receivables as a financial model that better fits their business needs. Generally speaking, you cannot expedite a loan from a bank particularly if you are a new or unestablished customer.
Disadvantages of Invoice Factoring
Factoring accounts receivables may cost you more than obtaining a bank loan in terms of pure dollar amount. The interest rates for business loans may be lower than the rates for factoring. When you choose factoring, you are primarily paying for the expedition process of unlocking payment that is tied up in your receivables or invoices. In addition, the factoring company is taking on a risk by paying you in advance for this invoice and your costs cover this risk. Business loans are less risky for the lending institution and thus cost less.
The Cost of Factoring Versus Bank Loans Is Often Negligible
Yet the key different here is that with factoring, you do not have to pay anything back to the factoring company. Once you collect your money, that is it; the transaction is complete. With a bank you get the money as a loan and then you have to pay it back with interest over time. Those in industries that regularly make use of factoring receivables write off the expense of factoring as part of the cost of doing business in the same way they write off other business expenses.
Factoring Is Accessible While Bank Loans Today Are Not
In the past several years, it has become more difficult for everyday normal small businesses to meet the lengthy requirements for a loan. Though it can vary by lending institution, most banks require that your business:
- be established or in business for at least three years
- generate a specific amount of revenue every month, such as $100,000
- seek at least $50,000 as a loan
- have a history of continuous profitability
- is not in higher risk or seasonal industries
These are just a handful of the requirements banks mandate before they will even consider offering a loan. Many small businesses do not meet these lengthy and difficult criteria. Invoice factoring companies recognize this common problem and offer small businesses a viable alternative to finance their businesses. The requirements for factoring include:
- Have valid, verifiable invoices and a customer with good credit score.
That’s pretty much it. Really.
Banks Have Fixed Terms, Factoring Companies Have More Flexible Ones
Obtaining a loan from bank means you are locked in for the length of the loan whether that is 2 years, 5 years, 10 years or more. You are obligated to meet your financial responsibilities to the bank and failure to do so could be loss of your assets. Regardless of what happens to your business going forward, good or bad, you are still required to meet your obligations or the bank will come and seize your physical possessions.
Factoring offers more flexible financing options. You can choose spot factoring in which you partner with a factoring company as a one-time arrangement perhaps during your busy season. You can choose to sell your invoices month-after-month for the length of a year to stay on top of your cash flow and get your business more established. Or you can choose to factor for 6 months, stop for a few months during a slow period, and then start up again. In this way, invoice factoring is flexible and responsive to your company’s individual financing needs.