When you are looking for commercial finance for your business you need to understand the difference between factoring and lending. It’s pretty simple so let’s clarify.
Lending is what most people are familiar with. You go to your normal financial institution, bank or credit union, and want to buy a house or a car and make an application for a loan. If approved, the bank gives you the money and you give them something in return as collateral or security. In the above 2 examples, that will be either the house of the car.
If you are a business, you might need the money to buy equipment or inventory or to fulfill a purchase order or make increased payroll. Depending on your financial institution some of that may be possible and some not. Where it it possible, it means you are taking on debt that will be reflected in your balance sheet.
Based on your finances, income and assets, the amount of lending you can received will vary. Since the lending is providing you credit, what is often called a credit line, anything you add to that reduces the amount you can borrow further. It may come to a point where you need some expansion capital, but your credit line is use up. What do you do?
Now let’s talk about factoring since that may be the answer to the above question. Factoring is the purchase and sale of an asset, namely your accounts receivable or your invoices. Since this is a sales transaction, you will receive funding but it will not impact your credit standing leaving it available for better use. Further, it is a only method of financing business-to-business (B2B) transactions.
One other explanation as to the difference between these 2 financing methods. In a loan transaction, there are only 2 parties: the lender and the borrower. In a factoring transaction, there are 3: the client (seller of the invoices); the factor (the buyer of the invoices); and, the account debtor (the client’s customer who is obligated to pay the invoice).
Are your B2B customers slow payers? Meaning whatever payment terms you have extended to them, 30 days, 45 days or 60 days, they always stretch it a bit. Or they are big customers who demand long terms like net 45 or 60 days. Then you could use some help, right? Here are some of the advantages to using accounts receivable factoring.
Fast Access to Working Capital
Factoring is a quick and easy method of accessing working capital with funds provided within 24-48 hours on approved invoices. Initial account setup typically averages less than 7 days from receipt of a factoring application.
Cash Flow Without Debt
Factoring is always a purchase and sale transaction and not a loan. Because of this, it doesn’t add to the liabilities on a business balance sheet making other forms of financing (inventory, real estate, equipment, etc.) more accessible.
Factoring contracts are typically for a year or less with
modest monthly minimums required. With
most factors, you may choose which invoices you want to factor each week.
Additionally, a factoring facility will automatically grow with a business as
Interested? The stay tuned for my next post where I’ll show
you a couple more.
Or give me a call and we can figure out which one suits you best.
In part 1, we talked about the basics of what factoring is.
Now to the “What’s in it for me?” part.
Here’s how factoring can help a small business:
Your Company, Super Clean Up, is a building maintenance
company that has a good reputation and what’s to leverage that to grow. So you
bid on a deal for a big building and get it! In order to fulfill the order, you
have to do 2 things: 1) you need to hire more staff that you will pay every 2
weeks; and 2) you need to accept 60 day payment terms.
Your reserve capital is low since you have recently invested
in some new equipment and you won’t be able to make payroll 4 times before you
get paid for your invoice. Luckily, your banker knows a factor and sets up the
After you and the factor have reviewed your company history, gotten to know each other a bit and he has looked at the deal, he tells you he thinks he can help.
Here’s where the factor money comes in!
You hire the new people and start the job. After 30 days you
invoice the building owner $20,000 on 60 day terms. The factor makes an advance
of $16,000 paid 3-4 days after they receive copies of the invoices. You now
have the funds to meet payroll.
After 60 days, the building company pays the factor $20,000.
The factor now pays you the $4,000 balance, less their fee. Industry wide, the
average is 2.5% per month for the 2 months. So 2.5% of $20,000 twice is
There is some more to the process and of course, some very important reasons why you might want to do this.
Factoring is a relatively simple form of commercial finance.
It is a form of asset-based finance (ABF) used by small-to-medium businesses
(SMBs) to finance their businesses when the banks say, “NO”.
In other words, ABF simply means you finance your business using your assets. In order to factor, the assets used are your accounts receivables, in other words, your invoices. Along with inventory and equipment, your invoices are considered primary assets.
So, What is factoring?
So back to factoring – here is a traditional definition:
A method of commercial
finance in which a business (known as the client) periodically sells its
accounts receivables or invoices to a specialized finance company (known as the
factor). Such “factored” invoices are purchased by the factor at a discount
over their face value. ~ Factoring 101 – A Broker’s Guide
In other words, this is called a discount transaction where the asset is sold at a small discount to its face value. When you factor your invoices to help finance your company, you will receive the proceeds from the transaction very quickly, but pay a fee for that.
Factoring is a very specialized form of ABF recognized worldwide as one of the most powerful forms of commercial finance available to small business owners.
If you’re a small business owner (one of the 26 million small businesses in the US today), you’ve probably gotten that answer at least once when you needed some extra money from your bank.
Maybe you are too young to get the credit you need. Or you’re at your credit limit. Perhaps what you are looking for is something your bank simply doesn’t do. In any case, you may walk away without what you need to fund your business expansion.
Don’t give up – there’s a solution! It is called alternative commercial finance. This is a large industry that performs a critical service to small-to-medium sized businesses like yours. Here is a source of financial alternatives to traditional loans and lines of credit.
What makes these funders unique is in the range offerings and the fact that many of them started their lives running a small business so they understand the challenges you face.Many tend to be risk takers, to some extent, that know that you need help that you can’t find otherwise. They know how to bring their expertise and funds to bear on business capital problems which are unique to the small business.
In future posts, I’ll explore several of these methods. We’ll cover in detail the several aspects of asset based finance (ABF) which are tailor made to a small business or one that is still young. The ABF funders look at things other than your income statement and cash flow. They look at your assets since they will be the backing for whatever funds you need.
In the next post, we’ll look at one of the oldest and most flexible forms of ABF known as accounts receivable factoring and how easy it may be for you to find the financing you need for your business.