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When to Consider Using a Factoring Company

By
Dawn Kuczwara
,
business.com writer
|
Mar 26, 2019
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> Finance
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Find yourself in a financial bind? A factoring service might be able to help.

Businesses, especially smaller companies and those just starting out, can sometimes find themselves in a bind. Say, for instance, they have an opportunity to buy out a competitor's stock, but they need to make the purchase immediately. Or they are financially sound but cash poor and in need of money to make payroll.

These same companies may have the money, if only they didn't have a stack of unpaid invoices – or, worse, one or two very large unpaid invoices. Money owed to them by great customers, but revenue not yet realized.

For companies that find themselves in these situations, a factoring company may be the solution. Invoice factoring can help a business get a boost of cash quickly, and with less paperwork and restrictions than a bank might require. When used wisely, factoring can be the answer you're looking for.

Editor's note: Looking for information on factoring services? Use the questionnaire below and our vendor partners will contact you to provide you with the information you need:

 

What is factoring?

Factoring is a means of unlocking the cash caught up in unpaid invoices. A factoring company gives a cash equivalent on a percentage of your unpaid invoices. Then they set to work collecting on those invoices. When an invoice is paid, the factoring company gives you the cash – minus a percentage for its services.

In some instances, factoring is a better choice than a bank loan. There is less paperwork involved in working with a factoring company than there is with a bank. Companies can get cash much more quickly. And because factoring companies are collecting against your invoices, they are more interested in the creditworthiness of your clients than your credit score. Even if your credit isn't perfect, a factoring company may still help you out.

Of course, there are downsides to factoring. Factoring is a type of loan, so if your customers don't pay the factored invoices within an agreed-upon amount of time, you'll need to pay back the outstanding debt.

Factoring can also be expensive. It can cost several percentage points more than what a conventional loan would charge. It's also likely a factoring company may charge per invoice. If you have many small, unpaid invoices, factoring may be too expensive. 

There are times, however, when factoring makes a great deal of sense, and is worth the financial risk and impact. [Want to learn more about factoring services? Check out our best picks.]

When to choose factoring

When considering options to improve your cash flow in the short term, there are a few instances when factoring becomes the logical choice.

Modern business moves swiftly, and sometimes opportunities appear and disappear fast. For instance, imagine you had the opportunity to land a large new client, but only if you could provide inventory very quickly. Your manufacturing processes are up to the challenge, but you're short on materials. If you had cash, you could ramp up and deliver for the new client. Factoring may give you the cash you need to seize the opportunity, knowing that you'll be making back any money lost on fees with the new client.

Sometimes companies use factoring simply to keep the business moving forward. If waiting on an invoice is putting your payroll at risk, it may be worth it to use a factoring company to ensure you can pay your employees, using the money from the factoring company as a stopgap measure.

Factoring can be especially effective if you have a large, well-known client who is slow to pay. Because your client is a good credit risk, a factoring company is likely to take on the invoice. The money can help you bridge the short time between when the invoice is given over for factoring and when the invoice is paid.

It's also a way to maintain a good relationship with a client you want to continue to do business with. Sending an invoice to a debt collector may sour the relationship. But a professional notice to a client informing them that their invoice is being factored can keep the relationship solid while putting cash in a business's bank account.

Factoring can be a boon for companies with short-term cash needs. It's a quick and relatively easy way to inject cash into the business for short-term expenses and growth. As with any business loan, though, factoring should be approached with caution. Carefully consider the terms and use only when it seems like an acceptable business risk.

Dawn Kuczwara
Dawn Kuczwara
Dawn Kuczwara is a former executive with more than 17 years of experience in technology. Now, as a professional writer, Dawn uses that experience to write about business, technology and leadership. When she isn’t wordsmithing, she spends her time doing improv comedy, reading, playing video games and hanging out with her family and two dogs, Pip and Zoe.
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