What is Factoring and is it a Good Idea?

Business.com / Funding / Last Modified: February 22, 2017

What is factoring, how does it work, and does it make sense for me? Find out that and what to do about it if factoring is an option for...

If you own a business that has customer payment terms of net 30, net 60, net 90 (or more), chances are you may have experienced cash flow issues at some point. If you've had cash flow issues, factoring your receivables to cover business expenses might be right for you. Factoring finance may help you grow -- or keep the business afloat - while you're waiting on payments from customers. Ironically, factoring can sometimes be very similar to the cost of accepting credit cards.  You'll see in a minute that accepting credit cards is a great example of factoring since the business owner is getting paid prior to the credit card company getting paid by the card holder.

Related:Debt Collection Strategies When Customers Don't Pay

The first thing you need to know to determine if factoring finance is right for you is to understand exactly what it is. Small business owners are often confused as to what it is, therefore knowing how it works is important.

What is factoring?

In a nutshell, factoring happens when a business sells its accounts receivables to a financing company to get a percentage of the total amount of receivables in cash. Most factoring finance companies will pay the small business owner up anywhere from 70% to 90% of the total amount of receivables owed. Once the accounts receivables are sold, the factoring finance company owns them and the customer becomes responsible for paying them instead of your company. This type of transaction gives you immediate access to capital and places the responsibility of collecting your customer's payment on the factoring finance company since they have purchased the receivables from you. To determine if this type of financing is right for you, keep the following in mind:

  • Factoring finance is usually best for B2B companies -- most factoring companies will only provide factoring to companies that sell products or services to other companies. If your company is a B2C company, you may want to consider a "merchant cash advance" instead. Merchant cash advances are best for business owners that accept credit cards or check deposits from their customers.

Related: Find a top vendor for merchant cash advances

  • Creditworthy B2B customers are required -- an important key to getting approved for factoring finance is having B2B customers that can prove their creditworthiness. Factoring finance companies will check your customer's business credit rating. If your customer doesn't have a history of paying on time, you may not qualify to factor your receivables for that customer.
  • The total amount of your receivables -- most factoring finance companies require you to have a minimum amount of receivables to sell. The minimum amount varies depending on the factoring finance company but usually a minimum of $10,000 in receivables from at least one customer is required.
  • Your customer payment terms -- depending on the factoring finance company, your customer payment terms will probably need to be net 30, net 60, or net 90. Anything beyond 90 days gets tough and the longer you factor the more expensive the cost gets so it can also get cost-prohibitive.

Related: Get a quick quote from an accounts receivable company now 

If you've determined that factoring may be right for you, the next step is to seek expert help. Finding a good factoring finance company is critical. Most good factoring companies are going to be pretty competitive with their pricing but watch the fees and add-ons.  There are companies like Durham Commercial Capital who do not require any "personal guarantees" from the businesses who factor their receivables and large companies like Bibby Financial Services who will normally require the business owner to also personally guarantee the invoices that get factored.  You can also contact the International Factoring Association for a referral.

Factoring is a great way to help with cash-flow issues and it can often be done at a very similar cost to accepting credit cards.  Take a look and see if it makes sense for your business.

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