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Small Business Financing Using Accounts Receivable

Provided by Buzgate.org Small Business Resource Referral Network, content partner for the SME Toolkit.

Speed up cash flow - Finance growth without borrowing or giving up equity by expediting payment of invoices through a process called factoring. A factor buys your invoice(s), paying you up front upon validating the creditworthiness of your customers and you get your cash right away. There is no limit to the amount of capital available and all your resources can be focused on sales and customer service.

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What is Factoring


Factoring refers to the process of selling your accounts receivable invoices to a third party who then performs the function of collecting the invoice. Called factors, these agents can move quickly to get funds to a business for a fee as a means of providing financing for growth. Most factors initially pay you in two stages; the majority (70 to 90%) up front on the initial advance and the balance when the invoice is collected, through the reserve release . Factoring fees range from 2% to 5% or higher depending upon a number of variables (see factoring fees).

Why (and when) factoring?

Cash flow is king in a business!

80% of business failures can be attributed directly to a lack of cash flow and/or working capital. A business may be growing leaps and bounds, but if monthly sales invoiced do not produce cash on time to pay wages or creditors, it may still fail from being cash starved.

Factoring allows a business to sell invoices to a third party, a factor , at a discount in return for cash advanced before the invoice comes due. In addition to the benefit of having cash on hand sooner to support operational expenses and growth, factoring does not usually tie up assets outside the business, does not involve the repayment of debt at some future point in time or if called on a certain date, and frees up internal resources normally devoted to tracking and collecting Accounts Receivables.

Factoring can be an attractive tool for many businesses but may be most appropriate for rapidly expanding operations. For example, it takes time to get an increase in a traditional bank line of credit. However, time is usually of the essence when a large order is received and requires additional financing for raw materials. Other less routine situations include; management buy-outs, acquisitions and restructures, turnarounds and delinquent tax situations. Business start-ups that have sufficient accounts receivable volumes and sales turnover levels will also find factoring a valuable financing tool.

Factoring Fees

While there is a cost to your business when you factor , this cost, or a portion of it, should be built into the cost of sales and/or be justified in terms of the value that the advanced cash on hand represents to your operation. Often businesses are able to increase prices or take advantage of supplier discounts and benefit from the enhanced purchasing power the additional capital provides them. In general, the following variables determine factoring fees:

  • Risk: refers to the credit worthiness of the account debtors (your customers).
  •  Maintenance: refers to the work involved in managing your receivables. In other words whether you have a large number of small invoices or a smaller number of large ones.
  • Time: refers to how long your customers take to pay. Time is money after all.
  • Volume: plainly stated means the higher the volume the lower the fees.

Any Factoring company that quotes you a rate without knowing all the particulars of your business is doing you a disservice and wasting your time. There are details that will not only determine the best factoring rate but also the services required to ensure its success. If factoring does not solve the problems it was intended then the expense would be much higher than anticipated.

Factoring fees do not vary much from factor to factor but they are often presented in radically different ways. They can be stated as; a one time off the top discount fee, a daily discount rate or even as a fee with a rebate. Clarity and track ability are important issues to consider. The end result should be a discount off the invoice similar to the merchant fees that credit card companies charge to their retail establishments.

Some innovative factoring companies have developed Asset Based Lines of Credit that incorporate the best of factoring (full accounts receivable management) and a line of credit (low rates charged only on the money borrowed). Qualifications would typically be higher. Fees are split between a Collateral Management fee and an interest rate on the monies borrowed.

Who Uses Factoring

There are many different types and sizes of businesses that find factoring a beneficial cash flow management tool. The key factor is to weigh the cost against the benefit of having the cash on hand sooner rather than later.

Qualifying for Factoring

The following characteristics are viewed when a business is evaluated as a factoring client:

  • Businesses owner's knowledge of and experience in their industry
  • The credit worthiness of the businesses customer base, and
  • The strength of the businesses receivables

Factoring vs. Bank Financing

Factoring can be a valuable alternative for securing vital working capital, when a bank may be unable to provide financing due to some of the following situations:

  • Start-up business with a limited track record
  • Rapid growth drives consistent increased capital needs
  • History of operating losses
  • Minimal or deficit net worth
  • Tax liens in place
  • Past personal/business bankruptcy or credit issues

Banks operate with tighter credit parameters due to the fact that they are operating with depositors funds or borrowed funds from the Federal Reserve. It is this fact that requires them to be more conservative with their lending practices.

Factoring for New Businesses

Relatively new businesses often require a high degree of funding flexibility where credit history is limited yet the promise of substantial growth requires substantial cash flows. Factoring can often be the ideal solution under the following common new business challenges.

Common New Business Challenges Solutions Where to Get Help
Can't get a credit line Factoring offers a means for securing cash advances against outstanding invoices without tying up personal assets or giving away any ownership or equity position. Learn More
Limited capital to fund operations and marketing.
Large order requires additional funding
Seek investment capital without giving up ownership/equity
Need to understand financing alternatives
Limited resources to properly manage accounts receivable
Vendor credit is not available for funding growth

Outsourcing Collections

Collecting money due from customers may be one of the most critical aspects of ensuring cash flow to support growth. As a small business, it can be profitable to rely on a factoring agent to perform this role in a professional and timely manner helping you to overcome the following common business challenges.

Common Accounts Receivable Challenges Solutions Where to Get Help
Afraid to ask customers for money Factors provide valuable services to validate customer creditworthiness such as credit analysis, credit guarantees and collection management to ensure that you're paid in advance and that your customers are satisfied. Learn More
Limited time and skills for developing a professional and consistent collection process
Don't have the staff to handle collections
Need to eliminate bad debt accounts
Desire quick and accurate account reporting
Need to access cash faster
Desire to improve credit rating
Want to eliminate COD Deliveries
Conflict between selling and collecting demands

Optimizing Cash Flow

More businesses fail through lack of cash flow than for any other single reason. Below are areas where having a lack of cash flow can seriously compromise the success of a business and how factoring can help:

Common Cash Flow Challenges Solutions Where to Get Help
Taking advantage of vendor discounts Factors advance cash to you against invoices at the time you have shipped the goods or completed the services so that you can fund purchases, payroll, seasonal expenses and other operational expenses. Learn More
Not risking the loss of vendor credit lines
Ensuring payroll is covered
Improving control over accounts receivable cycles
Avoiding morale problems when cash is tight
Miss short-term opportunities
Need vendors to be more responsive
Must reduce Days Sales Outstanding (DSO)

Factoring Calculator

Calculate the difference between profit over a one year time frame with and without using factoring using a Financing Spreadsheet Tool

Purchase Order Financing

Purchase Order Financing is used when a business does not have sufficient capital to produce an order. This situation can be common for start-up manufacturers or when a large order is received. There are two types of financing solutions that a factor can provide in these situations:

  1. Factor provides the client's supplier with a Vendor Assurance Letter that confirms that the supplier will be paid directly by the factor upon shipment of the order and presentation of the invoice to the factor.
  2. Factor provides the client's supplier with a Letter of Credit that guarantees that the supplier will be paid directly upon delivery of the order.

Funding Growth

There are a broad range of challenges faced by many small business owners when dealing with growth that a factoring relationship can productively assist with:

Common Growth Challenges Solutions Where to Get Help
The more sales you make, the more money others owe you, and the more you need to quickly collect to fund more sales Through factoring , cash against existing receivables can be made readily available to fund marketing, purchase technology, expand market share, improve vendor confidence and support other working capital needs. Learn More
Increased marketing costs to support sales momentum
Need to secure larger vendor credit lines
New technology requirements for better efficiency
How to fund growth without giving up equity
Opportunity to expand globally
Narrow window of new sales opportunity
Limited credit line availability or capacity

Factoring Terms

Understanding the language of factoring can help you to conclude when to use this powerful form of financing for your business growth and who to partner with to implement it. View Factoring Glossary.

10 Great Reasons to Use Factoring

  Factoring can be a powerful financing tool

  1. Accelerate cash flow - Factoring allows you to sell invoices to a third party at a discount, so that you receive the cash you need now to support operational expenses
  2. Financing alternativeFactoring is a powerful funding tool for supporting growth
  3. Fast payment turnaround - Factoring is simple to use where an invoice outstanding can be turned into cash on hand in as little as two days
  4. Simple to use - It is relatively simple to set up a factoring relationship
  5. Ready cash - Factoring means "ready access to working capital."
  6. Leverage staff time - A factor provides value-add services to ensure that who you do business with is creditworthy
  7. Professional Visibility - Factoring improve your business position with customers as the quality of products/services delivered is validated by a third party and invoices are collected in a professional and consistent manner.
  8. Success Factor - Using factoring is viewed by customers, vendors and the factor as a positive growth step to the ongoing success of your business
  9. Funding CapacityFactoring does not tie up other assets as collateral as with other forms of business financing
  10. No funding limits - There is no limit to the amount of factoring where all qualified invoices offer advanced, discounted cash flow.

Where to Begin

Establishing a new factoring relationship typically involves 5 to 7 business days whereby you will work with a Business Development Officer (BDO) at the factoring organization in submitting an application and financial information along with invoices to be factored.  Upon acceptance, a Security Agreement is signed, a UCC-1 is filed as the appropriate collateral, the customer(s) is notified that invoice collection will be direct to the factor and you will receive the discounted advanced cash.

As an ongoing client, invoices are submitted using a signed Schedule of Accounts, customer credit is verified accordingly and the cash advance is made.

To begin establishing your own factoring relationship, consider the following options:

  1. Call toll free 1-800-757-5895, or
  2. Download Factoring Application
  3. Download Personal Financial Statement
  4. Download Company Financial Statement

About Your Sponsor

"The Commercial Finance Group (CFG) provides working capital financing for small to medium sized businesses and specializes in assisting companies that are unable to qualify for adequate bank financing. By providing credit approval on orders, administering invoices and lock boxing payments, CFG has the flexibility to finance businesses that are undercapitalized, or in a start-up or turn-around situation."


Copyright (c) Knowledge Institute, Inc., 11 Court Street, Exeter, NH 03833, USA
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