When & How Does Factoring Work For Small Business Financing? | Behalf
Factoring For Small Business Financing: When it Works
Before your company begins factoring its receivables, it should consider whether or not factoring is a suitable financing solution. Every company has different business needs. Depending on your company’s business model and the source of its financial woes, factoring may or may not suffice as your best financing solution. You can either learn the hard way through trial and error or do your research. Like most small business financing options, factoring comes at a cost. The cost of factoring, however, can be much higher than most. Some factoring companies charge exorbitant rates and fees, while also putting your customer relationships at risk. To protect your company from predatory factoring companies, search for the best deals and look out for hidden fees and unfair terms. Factoring does not always help in the long run, but can be an important source of cash in specific business situations. This article describes the scenarios for which factoring works for small business financing and an alternative for when it doesn’t.
You need money fast.
Factoring is fast cash. Factoring companies sell their receivables discounted for a quick cash advance, withholding the fees and rates related to the service. The advance is only a percentage of the receivables, so you never receive your full earnings from those sales. If time is your priority, you may not mind a deep reduction in your company’s profit margin. 60-80% of your receivables is, after all, better than 0. You can look for factoring companies with larger advance rates and fair terms to mitigate the loss.
You rely on paid receivables for working capital.
If paid receivables are your company’s main source of working capital, factoring might be able to remedy your working capital shortage. Working capital is the money your company uses to cover its operational expenses. Companies with slow paying customers often accumulate outstanding receivables, which in excess can create a working capital deficit. Factoring alleviates this type of working capital shortage, but if your company is hemorrhaging cash from an unknown place, factoring might only bring temporary financing relief. Carefully assess your company’s financial status and whether or not paid receivables are crucial to generating working capital before you commit.
Your customers are creditworthy.
Factoring is not for every one of your customers. Not only are factoring companies selective with which customers they approve, they also hold your company accountable for the customers they do agree to factor. Factoring companies do not like risk. They will reject your customers that they deem high-risk or uncreditworthy. Even the customers they do approve could fail to pay; in the end, your company is accountable for those customers’ debts, as well as your own. Considering how steep factoring rates and fees can be, only factor customers when you are confident they are creditworthy.
Your company offers trade credit.
Many companies offer trade credit to their customers. Though trade credit generously extends the amount of time customers have to pay for goods and services, they also attract slow, non-paying customers. As a result, outstanding receivables pile up and companies experience a gap in their cash flow. For some companies, trade credit is a necessary evil they have to consider to keep up with their competition.
If your company finds itself in one of the above scenarios, consider giving factoring a try. If not, don’t worry. There are more affordable financing solutions that help companies get through these scenarios and more. Consider eliminating collections completely and accelerating all your receivables by offering your customers third party financing. For example, when you invite customers to pay you with a Behalf business purchasing line of credit, you increase their buying power and empower them to choose their own payment terms. It is a win-win: you will get paid instantly and your customers can extend their timeline for payment up to six months. With Behalf’s small business financing solution, you don’t have to sell your receivables to get paid fast.
Learn more about how Behalf’s financing solution is transforming the way businesses buy and sell here.