Business Factoring is an alternative way for growing companies to get cash quickly. In this blog, with help from our friends at Prairie Business Credit, we’ll run through everything you need to know about Business Factoring in 2023.
Business Factoring is a financing opportunity. In fact, it’s one of the oldest ways of financing, dating back to Colonial America when colonists financed their own economic growth prior to the Revolution.
It’s typically not a long-term financial solution, but under the right circumstances, it can be an invaluable tool for rapidly growing or struggling businesses.
So, what is it?
Business factoring is a financing method that allows you to sell your company’s unpaid invoices or accounts receivables to a third party (known as a Factor) at a discount.
Essentially, The Factor pays you for your unpaid invoices and becomes responsible for collecting the invoices from your customers on your behalf. Then, you will compensate The Factor with a fee for each paid invoice.
The Factor waits for your invoices to be paid, while you get money immediately to take advantage of new opportunities. With ready cash, you can continue to produce and deliver on sales that will grow the company.
Yes, your company gets immediate access to cash without having to wait for the 30 to 100+ days you normally collect your receivables.
Sound enticing? There’s a reason why it’s been around so long!
Here’s how it actually works.
Business Factoring is used to temporarily alleviate any cash flow issues for companies.
Factoring is most often used as a stepping stone, to get your company in a position to take advantage of growth opportunities. Once your financial position makes your company more “bankable,” you may qualify for more traditional means of long term financing.
What you spend the cash on will depend on your unique situation, but commonly it’s used to take advantage of vendor discounts, maintain inventory levels, purchase equipment, make payroll, procure materials, upgrade hardware, pay taxes, invest in marketing, and so on.
Essentially, the cash you get from business factoring can be used for anything that will keep the company growing.
Essentially, any company that needs to bridge the “cash flow gap” is a good candidate for factoring.
Prairie Business Credit listed a few good characteristics in their Just The Facts Guide:
If your business:
What does closing the cash gap mean?
As we always say at U-Nique Accounting, cash flow will make or break a company.
In fact, 80% of small businesses that go out of business do so due to poor cash flow visibility.
Understanding the “cash gap” is helpful in understanding your cash flow issues.
The cash gap is the number of days between a company’s payment for materials or services and its receipts from product sales.
You know, the stressful days when your bank account is zero after paying expenses while you’re waiting for invoices and sales to hit.
If your company is experiencing rapid growth, it could find itself on the verge of bankruptcy, simply because cash outflow exceeds inflow for too long.
If a lack of cash is preventing you from making the next sale or holding onto a customer, Factoring may be critical.
Ask yourself these questions:
o Is the gross margin on that next sale greater than the cost of factoring?
o Can the savings gained through trade discounts, competitive credit terms, and reduced administrative and collection costs offset the cost of factoring?
o Will accepting new business and keeping it by factoring increase the bottom line?
If the answer is yes, factoring for immediate cash should be a consideration for your business.
As experienced business accountants, we help companies manage their cash flow and often help determine financially viable options for quick cash. You can book a free call with one of our accountants to see how we can help.
Discount rates per invoice vary by industry but 2-6% is common.
Costs are tied only to sales.
Factoring provides cash which allows you to pay suppliers and creditors on time. Meaning, it can improve your credit rating.
Additionally, your company becomes eligible for better discounts and terms from suppliers.
Here are a few other advantages of Factoring:
Which is better for a business in need of cash – using a line of credit or business factoring? Besides Factoring being an asset-based transaction vs. the revolving loan of a credit line, here are other factors (pun intended) you should consider as well.
A Factor’s discount rate is generally less expensive than the interest rate of a business credit line. Especially if your company is hardly the darling of credit providers or has a relatively high-profit margin.
The creditworthiness of your customers and NOT your business is one of the first things a Factor looks at. How long does this customer usually take to pay? Partial or full payments? The rosier the credit checks on your customers, the sweeter the discount rate is for you. The due date plus the value of an invoice also comes into play. While some Factors offer discounts only for due dates of up to 60 days, others charge a higher rate for anything beyond.
On the other hand, depending on the loan amount, repayment term, collateral pledge and your firm’s credit score, a business line of credit can set you back by quite a lot. Traditional banks will offer an APR of Libor/SOFR + a few basis points, while non-traditional banks can get expensive. These rates can typically range up to 60%, but some can be even higher.
Many factoring lines are low-maintenance and extend quite naturally from your normal operations. All you need is common business sense to keep a factoring line going – work with reliable customers that pay on time and keep your business as a going concern.
Maintaining a line of credit can be more onerous. That’s because most come with covenants such as detailed financial records, healthy financial ratios, and a certain level of corporate net worth or market value.
Needless to say, these tend to favor larger, rather than smaller, companies.
Again, a line increase for factoring is pretty straightforward. Because it often means you are sending out more invoices to an expanding customer base for a growing business. It’s a clear win-win because a Factor stands to profit directly from yours, as long as your new customers are good, paying ones.
But not as much when it comes to increasing a credit line. Even when your tills are ringing louder and faster, a lender would want to look again at your cash flow, assets, or even the entire financials. Some could demand a larger collateral when the equivalent for factoring is simply the accounts receivable themselves.
Will the benefits of Factoring outweigh the cost? This is the most critical consideration and one we recommend seeking out the help of an experienced accountant for.
The cost of capital should be viewed as an investment that will advance the business, just as a new piece of equipment.
You would not spend money on a piece of equipment unless you were convinced that it would increase sales and profit or reduce costs.
The cost of acquiring cash through Factoring should be weighed in the same way. The immediate and ongoing availability of cash must help to increase sales and profit.
Here’s a real-life example of a company that utilizes factoring from Prairie Business Credit:
Let’s summarize the financial impact on an actual company that uses factoring to fund its sales growth.
This company began with $1 million in total sales.
By Factoring, they were able to double sales to $2 million in the following year. They paid $40,000 in factoring costs, and increase their profit nine times, to $180,000.
The Factoring cost is 4% and $1 million of receivables were factored in the second year.
Cash flow is a complex topic for businesses.
If you need help with your financials or projections before deciding the best route for you, or need help to Factor, reach out to us at U-Nique Accounting.
15 years of experience in providing accounting and CFO services have given us a truly unique perspective your business deserves.
Book a complimentary 15-minute call with us today to hear and see it for yourself.
Until the next time!
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