Factoring 101: All You Need to Know
As peculiar as it might seem, factoring has been around for more than 4,000 years and yet not everyone is aware of its purpose.
Factoring is one of the most prevalent and easiest ways of speeding up a company’s cash flow, and it has recently become an important topic gaining hype with the general public.
Interconnected with the continuous growth and expansion of alternative financing, factoring is clearly gaining momentum and it should be registering on your radar, too. But how much do you know about it? Here is everything you need to know about factoring:
What Is Factoring?
Factoring is one of the oldest forms of business financing, dating back to 2000 B.C. Traders in ancient Mesopotamia are thought to have used an early form of factoring when making international business deals. Also known as “debt factoring,” it is continuously growing in popularity and is now available to businesses of all sizes across the world.
The main advantage of using factoring is that it speeds up cash flow. It’s an especially good financing method for companies dealing with an increase in demand and/or bigger orders to fill. These companies would use invoice factoring as a bridge loan.
Here’s a step-by-step overview of how it works:
- An alternative financing company buys the invoices you have issued and pays you typically around 85% of the value upfront.
- The company then notifies your customers of the invoice and collects the full amount due.
- Once the sales ledger is managed and money from the customer collected, the other 15% of the invoice value is made available to you.
- You’re naturally requested to pay the financing company a discount charge and any additional fees.
Note: The latter two (discount and fees) are not set amounts across the board, as each factoring company sets their own rates, so make sure you discuss these before striking a deal.
From around the 1300s when factoring was modernized in England up until the 1970s, it was mainly used by clothing manufacturers to boost their working capital. That allowed them to buy raw material earlier and produce more garments to take full advantage of existing high demand.
However, after banks adopted factoring financing and started reaching customers through the internet and cloud media, the 2000s witnessed a rise in factoring use by companies of all sizes. Today, invoice factoring is slowly becoming one of the most popular alternative financing methods in the world.
Pros and Cons of Factoring Finance
Similarly to all other types of finance, you need to carefully consider and weigh in the positives and negatives before making a decision to use factoring or not. Also read up on what is invoice discounting, a very similar financing method to make sure you know the difference. Most importantly, you need to be aware of all of the terms and aspects of this finance model and be objective of your current situation. Here are some of the things you might want to consider before choosing between invoice financing or a bank loan:
Pro: Quick Working Capital, Great for Fast Growing Companies
While different factoring companies take different amounts of time to process your application, you generally get the money you need to finance your business functions in no more than 10 days. Sometimes, you get it even quicker — within one to three days. It is a great aspect to consider, especially if you’re running a fast growing company and need your capital fast.
Pro: No Dependence on Credit Standing, Great for New Companies and Turnarounds
Unlike bigger financing institutions like banks, most companies which offer factoring will not request any financial background checks. Which, in turn, is a massive plus for all those new companies that are facing a huge demand but need finance quickly to satisfy it. For those without a longterm record of financial stability who may not qualify for regular loans, factoring offers an easy way to stay afloat. This is a major positive aspect for new companies and turnarounds, as you’re working to solidify your business model so you can gather the hard data to prove your stability.
Furthermore, the approval rates and satisfaction levels of the firms which use this alternative method of financing are constantly on the rise.
Con: Factoring Can Get Expensive
On the other hand, there are a number of factors you should consider before selecting factoring as your preferred alternative financing method.
It’s been noted that factoring can become expensive pretty quickly. Typically an interest rate is around 2–5% percent for the first 30 days (that’s quite good). However, after that you might be charged a 0.067% to 0.125% fee for each additional day.
A tip to avoid huge charges: choose the best provider by carefully selecting the loaning body and familiarizing yourself with their terms. Ask for references or search the web for opinions and testimonials, in addition to looking up their social media score which could be used to support the loaning company’s reputation and image.
How Can Your Business Benefit from Factoring?
There are two main reasons why companies choose to use factoring: it’s easy and quick. Since factoring doesn’t require that you go through huge financial institutions and comply with their long lists of terms and conditions, it’s a great alternative for companies that need capital right away, but haven’t been around for long.
Moreover, small and medium-sized enterprises are the ones highly likely to benefit from factoring in a variety of ways. Not only is it among the easier financing options for growth and expansion, but it also might help you better service your existing customers. The above will result in higher satisfaction from all parties involved within your business.
At FundThrough, we use factoring to help businesses around Canada and the US reach their goals. The only thing you need are the excellent invoices from your customers.
Our invoice factoring options do not require any financial history, thus making the application process quick and easy. Furthermore, you are ensured a professional service from financing experts that will design a loan especially for your needs. For your ease, you get to draw money whenever you need it, without minimum sums or commitment periods.
3 Popular Factoring Misconceptions
There are a number of misconceptions that are attached to factoring mainly due to misinformation. Those range from bad reputation to “your company is too small for factoring.” However, we’re here to prove these wrong:
Misconception #1: Factoring alienates your customers
What factoring offers is a way to fully execute your aim to be extremely customer-centered and manage your sales and deals in an especially timely manner. You are therefore equipped to meet the needs of your customers, thus building up a better relationship with them. There’s no way collection calls can be avoided (it’s part of the system), and your customers will be made aware that you are using factoring. However, by choosing the right loaning company you ensure that these calls will be handled professionally, with great care.
Misconception #2: Factoring only works for big companies
Small to medium sized companies are factoring’s largest share of customers. Nonetheless, factoring is an easier and faster method of timely satisfying a demand which some enterprises wouldn’t be able to meet with traditional methods, making internal debt financing a preferred method to reach their goals.
Misonception #3: Using factoring means your company is unstable
Many people think that if companies need external financing, they are probably close to financial failure. Since factoring genuinely makes a company more financially stable, this statement is completely untrue. Factoring, and invoice discounting, help companies expand and satisfy their list of loyal clients in a professional and trust-building manner. This results in higher success for the company in the future.
It’s clear why factoring is gaining track within the expanding alternative finance world. When traditional loans won’t do the trick, it’s time to look for alternative options which suit your needs. And if you run a new company which needs working capital to fill your orders and grow, factoring might be your best bet. Get in touch if you’d like to get a quick quote or discuss your financial needs and see how we can help.