When to consider factoring for your small business

Factoring refers to a practice where you sell your receivables for a discount before they are due. Factoring has usually been used in the clothing industry. Today, factoring companies are willing to buy creditworthy receivables from just about any industry. So, when should you consider factoring for your small business?

Most often, factoring is used by rapidly growing businesses that are facing short-term cash flow issues. Factoring is kind of an expensive way to obtaining financing for your small business. You are essentially paying for the cost of the capital, bad debt, and the paperwork that factoring has. If you can finance your business through other sources, you will most likely save money.

When considering factoring for your small business, here's what is involved:

Who purchases receivables?
Businesses sell invoices for payments in the future because it can generate cash faster than if they tried collecting money on their own. Finance companies, some banks, and all different kinds of financial companies will purchase receivables. Businesses with smaller monthly amounts of receivables, less than $10,000, may need search to find a factor company that will purchase its receivables. If this is the situation that your business is in, don't worry because those companies can be found.

What are the fees associated with factoring?
Once you and the factoring company determine which invoices it will buy, the factor will typically pay you an advance. They may pay you a percentage up front and give you the rest when your customers pay their bill. Factors' fees differ depending on the size of your invoices, and what your customers' credit is like and the number of days in your collection rotation. You should expect to pay anywhere from 3 percent to 7 percent or more of the total the factor collects.

There's good and bad to factoring. Let's take a look at the pros and cons of factoring for your small business.

The pros:
It's great for companies to sell future receivables, including credit card receipts. Typically, companies buy them at a discount for cash upfront.

It is a quick way to get cash in advance. Overhead charges get automatically reduced with the cut in invoice processing.

The business owner doesn't have to worry about invoice processing like depositing checks and entering payments.

It is an easy way to have access to unlimited capital for the business.

The cons:
Factoring can place businesses customer relations in the hands of another company. When aggressive collection procedures are involved, this can ruin relationships and drive away customers.

Factoring can also show customers that your business is struggling and may not be a reliable long-term supplier of services. Borrowing against receivables also accumulates debt on your balance sheet which does not look good either.

A factor can turn down invoices of customers that don't have good credit, or it can stop paying you on accounts that remain past due. If you have a lot of customers in debt to you, factoring probably isn't a good solution.

The cost of factoring is higher than the cost of a short-term business loan. Many businesses turn to factoring as a last resort when they can't get bank loans or lines of credit.

So, is factoring right for your small business? Here are some things to look for to see if you are a good candidate for factoring:

Your company has a turnover of at least $25,000-$50,000. Some factors will consider smaller businesses.

It is best if your small business has more than just a few customers.

Customers accept a reasonable period of credit.

Customers accept the standard payment terms for the industry.

It is possible that you will still find a factor if your business doesn't fit these criteria's.

When to consider factoring for your small business can be a difficult choice. Remember, factoring can be a piece of mind for your small business. Each person involved has responsibilities and must live up to them in order for the factoring to work. If you need cash to run your business, capital expenses, payroll and other expenses, factoring could be the perfect solution for you. Take time to consider all the possibilities and get your small business up and running smoothly and successfully.