When a small business is not able to get a traditional line of credit from a bank, factoring can be a quick and easy solution.  Factoring provides immediate cash in exchange for selling outstanding invoices to a factoring company.  Factoring provides many benefits for B2B companies with outstanding receivables. But there are also disadvantages, particularly for certain industries or types of businesses.  Below list the main advantages and disadvantages of factoring.

What are the pros of factoring?

1. Immediate cash and quick access to working capital
The most valuable part of factoring gives you working capital fast, which allows you to close the gap on your cash flow needs. By having available cash flow, it allows you to make payroll and pay expenses and take advantage of business opportunities without waiting 30-60 days for your customers to pay.

2. Flexibility and unlimited growth
By having a factoring line, it gives you the flexibility to use it as much or as little as you need for your business.  If you do not use it, you do not pay any fees.  Additionally, as the company grows, so does your factoring line. This allows you to have continual access to capital.  Lastly, factoring can also be a short-term or long-term solution depending on your industry and business needs.

3. Quick set-up
The underwriting process connected with traditional bank financing can be very time consuming; whereas with factoring, a factoring line can usually be set up within 3-10 business days.

4. Easier approval and higher credit limits based on your client’s creditworthiness
Factoring companies primarily look at the creditworthiness of your customers for repayment.  Factoring is a great option for companies with recent losses, just starting, customer concentrations, seasonality, or rapid growth.

5. Collateral is the invoices themselves
Many factoring companies take only your invoice receivables for collateral instead of a blanket lien on all your assets, which can include real-estate, inventory, equipment, etc.

6. Outsource tasks/manage credit risk for your customers better
Many factoring companies help conduct credit checks and analysis as well as keep records of accounts receivable and provide reporting. This allows a business owner to know who they are doing business with and hopefully lead to fewer bad debts.  It also allows a business owner to better focus on the responsibilities of their company.

7. Allows you to retain all your equity.
When a company gives up equity, they also give up a portion of their company and control.  Additionally, if selling equity during financial distress, the company is most likely not getting the best price.

What are the cons of factoring?

1. More expensive than traditional bank financing
Factoring fees have come down over the years, but a factoring line is more expensive than a traditional bank line.  Typically a factor will charge between 1-5% of total invoice amount in service fees. Being able to receive cash quicker and take advantage of business opportunities often outweigh the fee.

2. Potential liability for overdue invoices
Factoring companies are not collection agencies.  Therefore, bad debt will go back to the company to handle.  If the debt is not paid, ultimately, the company is responsible for unpaid invoices.  If a certain invoice goes beyond 90 days, standard practice in the factoring industry is to request payback or request replacement with another invoice .  In some cases though, factoring companies are flexible and work with you for the best solution.

3. Limitations
Factoring is limited to B2B (business to business) companies only and available to companies with eligible accounts receivable.

4. Possibility to be labor intensive
With factoring, it usually has a little more administrative duty associated with it.  To factor invoices, often times, a company needs to send in a copy of their invoices and backup documentation to get funded.

5. Guaranty
Many factoring companies require a guaranty for the factoring line, which means the guarantor is responsible for any outstanding debt or unpaid invoices if the company fails to pay.  Often times, banks require this as well.

6. Notification
In most cases, a notice of assignment is sent to the debtors letting them know that an assignment of invoices has taken place.  Most companies are familiar with this process and have very little issue with it.  If you choose a reputable company, you should be able to trust that the process will go smoothly.

In conclusion, a company should weigh the pros and cons prior to making any decision.  Invoice factoring is not for every small business, but it can be a great solution for many that need working capital to solve their cash flow needs.  At Cash Flow Resources, we provide customized solutions for our customers.  We will even handle small businesses that are too small to go to a bank.  For me information, call us at 504-522-6065.