The Great Recession and resulting credit crunch has caused banks to reduce access to business loans and rescind lines of credit. These effects are still being felt today. To compound the problem, many companies find that their suppliers are demanding payment sooner while their customers are taking longer to pay on invoices. And yet they are expected to make payroll, pay taxes and meet expenses NOW!
In this perfect storm of economic turbulence, how do you survive?
The answer may lie in a funding service used by Fortune 500 companies but that, oddly, is relatively unknown in the small and medium size business market. The method is a highly effective process called “factoring.”
What is Factoring?
“Factoring” is a financial tool for business that provides access to working capital without adding debt.
Factoring, by definition, is the process of selling commercial accounts receivable at a discount. It enables a business to extend payment terms of thirty or more days to its customers without having to wait that long to receive its cash. It stabilizes cash flow and provides the working capital to get on with the business of doing business. The service is straight forward, cost effective, easy to implement and tax deductible.
Depending on the circumstances, factoring may be the ideal financial tool.
How does the process work?
Companies with B2B transactions are candidates for factoring. Once product or service has been delivered and invoiced, the invoice can be sold for cash. The majority of the invoice value is transferred at the time of sale. The factoring company will interact with the recipient of the product or service to have them remit payment directly to them. Once payment is received, they deposit the balance of the invoice value (less the fee) into your bank.
Not every company qualifies for the service, but the probability of qualification is much higher than other financing options (such as a bank loan).
The reason has to do with the three-way relationship of factoring services. There are three parties in a factoring relationship: you, your clients and the factoring company. Where a bank will scrutinize your credit before providing a loan, factors scrutinize your customer’s credit because they are the party responsible for honoring the invoice. The underwriting criteria are different, and in many ways, more liberal than those of a bank.
Top-tier factoring companies also provide two other valuable services to their clients – credit assessment of prospective customers and receivables management. In essence, they become your outsourced A/R Department.
Here’s why that’s important: In small and medium size businesses, the pressure to accept a prospective customer, simply because they wish to buy, is very strong. However, doing business with a poor credit risk company can seriously endanger a business. A factoring company helps minimize that risk by performing credit assessments on each of your prospective customers.
Furthermore, by managing the accounts receivable process, they work with your customers to ensure that everything about the transaction is in order. They handle receipt of payment and depositing of funds. Having the factoring company do this work means you do not have to hire someone to handle those functions.
Is Factoring Right for Your Business?
Factoring has been an integral part of growing businesses for centuries. It was a major component of the economic growth of the American colonies in the seventeenth and eighteenth centuries and is often used by today’s mega-corporations.
As a financial tool, factoring is frequently used a) by early stage companies, b) in times of rapid company growth or, c) in times of economic stress. For early stage companies and during rapid growth the demand for cash is often much greater than the cash on hand. In times of economic stress credit is tight and customers take longer to pay.
These are realities of the business cycle. The prudent business owner will recognize the reality and take action to navigate his or her company through turbulent economic waters.
Factoring can help.