Factoring of accounts receivable allows small businesses to send their accounts receivable and other invoices to a financial company (“factor”) that will pay them immediately. While this type of financing adds an extra level of cost to the return on sales, it can turn out to be a superior financing tool.
Factoring of accounts receivable makes more sense for a small business than lending opportunities available to larger companies, such as utilization of a revolving credit line (“revolver”). Cash advances are usually too expensive for the average small business. Factoring of accounts receivable will allow companies to get the majority of their accounts within a matter of days. Instead of waiting for 30 to 60 days, a business can have access to their closed sales almost immediately.
While credit cards are very common, they have limits on the total size that will affect credit scores and overall access to cash – not to mention this method has much higher interest penalties than would be incurred by factoring of accounts receivable. In addition, unlike credit cards, factoring provides a line of credit based on sales and not a company’s total net worth. Equipment leasing and more traditional loans are time consuming and generally based on past financial performance. Factoring is not limited but based on the company’s sales and accounts receivable.
For a small business or a start-up, factoring of accounts receivable is a very attractive proposition. It allows a company to immediately reinvest and utilize its sales by turning them into an immediate cash flow. A home equity line, while an alternative, is not a superior alternative to factoring of accounts receivable since it directly affects the credit score of the proprietor and may overstep many of the legal safeguards that exist in corporate structures such as the limited liability company (LLC). While the home equity loan may not affect the company’s balance sheet (because it will affect the individual proprietor’s finances), neither will factoring. Factoring is an off-balance sheet type of financing and will not show up as debt on the balance sheet (debt increases the companies cost of capital).
Finally, one of the more attractive features of factoring of accounts receivable is that this exercise also aides in the collection of accounts receivable. It limits the necessity of having additional back-office resources dedicated to the collection of accounts receivable. By engaging one of these financial companies, they not only recover sales for your company, but they will also allow you to access this money much quicker.