Is Factoring Receivables Right for Your Business Needs?

Struggling to ensure that your business has adequate cash flow? Most small business owners and entrepreneurs find themselves in this position all too often. While you might think that obtaining a loan or a line of credit from a bank might be the only solution to your liquidity challenges, that might not be the best option. Factoring receivables can offer many benefits, as well as access to the capital that you need quickly. Is factoring receivables right for your particular business?

What Does Factoring Really Mean?

Before we dive into exploring how factoring receivables might be beneficial to your business, we need to first establish what it is. Factoring receivables is pretty much exactly what it sounds like. You take an unpaid invoice from a customer, and you sell it to a factoring company.

That company then gives you an advance on the amount of the invoice, and when your customer pays, you’ll receive the balance of the invoice, less the factoring fee that you agree on with the company when you sign the contract.

That’s really all there is to it. It’s simple, fast and effective, and it ensures that you have access to the capital looked up in your own business.

However, factoring receivables is generally only available to B2B companies. If you operate a B2C company, you may or may not have access to this type of financing.

Why Should You Consider Factoring Receivables?

Factoring ReceivablesNow that we’ve established what factoring receivables is, it’s time to dig into why you might want to consider this financial tool. While it can be highly beneficial for many businesses, it’s not necessarily ideal for all needs. So, let’s dig into what it can offer you, and how that might allow your business to grow and thrive.

Speed: One of the most important considerations here is the time it takes to obtain the funding you need. While factoring receivables is more expensive than going through a bank, it’s much, much faster. You might have to wait 30 or even 60 days to get access to a loan or line of credit from a bank or other conventional lender.

During that time, you’re still struggling to make ends meet. With factoring, you generally have your money in hand in just 24 to 48 hours. That means no more waiting around, hoping that you can make it until your loan is approved and processed. It also means that you’re able to take advantage of opportunities with very short notice.

It’s Your Money: Unlike a loan, which is money you borrow from a bank, factoring receivables only unlocks the capital you already possess. Many companies might have a solid financial foundation on paper, but in reality, most of their capital is illiquid, meaning that you cannot access it very easily.

With factoring, all you’re doing is selling an existing asset to obtain the value it contains. In this case, you’re selling an invoice. That invoice represents money owed to you by a customer for products or services. With the right factoring company, you’re able to convert outstanding invoices into working capital that you can use immediately, for anything you might need, from payroll to business expansions.

It’s Not a Loan: Back on the topic of conventional lending, you’ll find a number of benefits due to the fact that factoring does not constitute a loan. Again, it’s just a means of gaining access to capital your business already possesses.

A loan, on the other hand, is just more debt. The more debt your company accrues, the deeper you sink and the harder it is to dig yourself out of the hole. Because factoring is not a loan, you’re not adding more debt. In fact, you can use the money to pay off debt and gain some breathing room.

You Gain a Helping Hand: While not true across the board, many factoring companies offer additional services that can provide you with increased value beyond the capital you free up through the sale of invoices. Quite a few factoring firms have started offering back office services, including billing, collections, credit checking and more.

By taking advantage of these services (with the right factoring partner), you can free up your time to focus on business growth and success, rather than spending hours per week handling billing and invoicing, attempting to collect from clients and other administrative tasks.

A Word of Caution

With all of that being said, there are some potential downsides to factoring receivables that you should be aware of.

Control: When you factor an invoice, it’s possible that the company you work with will require you to factor all invoices from that client moving forward. A long-term contract may or may not be a good thing, depending on the amount of control you wish to retain here.

Most factoring companies take over the billing and collections process, too, which means even less control on your side. If you’re a micromanager, then this might not be a good option. Of course, you might be completely fine with giving up some measure of control in order to realise the significant benefits offered by factoring receivables.

Your Customers’ Creditworthiness: Let’s put this as bluntly as possible. If your customers represent significant risk of nonpayment on their invoice, you will not find a factoring company to work with you (and you probably shouldn’t be doing business with those customers, either).

The entire factoring process is based on your customers’ creditworthiness, and if they’re too risky, then a factoring company will not be able to justify buying the invoice from you. In order to ascertain the level of risk, a factoring firm will check your customers’ business credit rating.

Minimums Matter: In order for most factoring companies to buy an invoice, it needs to be worth their time. Most firms have a minimum amount in place that you’ll need to meet before they’ll do business with you. That’s not necessarily true for all companies, but it does apply to most.

You can get around this by factoring the invoices for more than one customer, or by working with a factoring company that specialises in your industry. For instance, if you’re the owner of a small trucking company, chances are that you might not meet the minimum for a generalist factoring company. However, a firm that specialises in the logistics industry would probably be willing to buy your invoice(s).

Is Factoring Receivables the Same Thing as a Merchant Cash Advance?

While both factoring and MCAs (merchant cash advances) use the term “advance”, they’re not even remotely the same thing. Factoring an invoice is just selling an asset that your company already owns in order to get liquid capital to meet your cash flow needs.

A merchant cash advance is actually a loan. The lender will inspect your receivables to determine how much they are willing to loan you. However, it’s still debt, and there’s still the problem of having to meet credit requirements. Of course, you also have to pay the loan back, which means you’ll ultimately be hurting your cash flow situation.

With that being said, MCAs can be valuable tools. If you don’t feel that factoring is the right path for your specific needs, a merchant cash advance might be an option.

How to Choose a Partner for Factoring Receivables

If you’ve been convinced that factoring receivables is the right path to ensure you have access to liquid capital, you’ll need to find a partner. This is where things get tricky. Canada is home to a very, very wide range of factoring companies. Some of them are definitely worth your time. Some of them should be avoided. Others might offer some benefits, but not be a good fit because they lack experience with your specific industry.

Recourse or Nonrecourse: Both recourse and nonrecourse factoring are available, but they’re very different. With nonrecourse factoring, if your client fails to pay their bill, the factoring company assumes full responsibility. In recourse factoring, you’re responsible if your client doesn’t pay, and you’ll need to either factor more invoices, or repay the advance the company gave you.

Both options have their pros and cons, and you’ll need to choose carefully between the two. Understand from the outset that while it seems like a better option, nonrecourse factoring is generally more costly, while recourse factoring is less expensive, but carriers greater risk if you’re not sure that your clients will actually pay their bills.

Specialisation: One of the most important things to consider first is whether or not a specialist would be better than a generalist for your specific requirements. If you’re in the construction, trucking, technology or staffing industries, a specialist factoring company is probably the better choice.

These firms work exclusively with businesses in your area, and they are intimately familiar with the particular challenges that you face. You may also find that they are capable of offering unique perks. For example, a trucking industry factoring firm might be able to offer access to discount fuel cards to help you save money.

Cost: While you’ll pay more for factoring than you will in interest on a bank loan, you need to drill down to what the actual underlying cost will be and how that cost is assessed. Most companies will charge you between 1% and 5% of the invoice total per 30 days (which means you’ll be billed three times on an invoice that’s 90 days out).

However, some companies hide additional charges and fees in the fine print on their contracts. Make sure you look at any contract (and other information provided by the factoring company) very closely or you could find yourself paying more than you should.

How Many Invoices: Some factoring companies allow you to factor invoices as you choose, while others will require that you factor all invoices from a particular client moving forward. Know which method fits best with your needs and find a factoring company that will work with you in that way.

Advance Amount: You’ll definitely want to know how much the factoring company will advance you on each invoice. In general, you can expect anywhere from 70 to 90% of the invoice total, but this is not set in stone.

Some companies advance more than this, but make up for the difference in additional fees and charges. Other companies might advance a seemingly low amount, but have few additional fees, meaning that you ultimately save more money over the long term.

Reputation: Due diligence when choosing a factoring partner is crucial. You need to research each company you’re considering. Dig into their customer service record, their reputation and more. The more information you can find about any factoring company, the better you’ll be able to judge whether they’re worth your time and avoid potentially problematic companies.

A Helping Hand

Finding the right company for factoring receivables can be a daunting, lengthy process. You’ll need to conduct quite a bit of research, interview companies, compare contracts and services, and more. Of course, every minute you spend researching a factoring company is another minute you’re not growing your business. It’s enough to make you want to take shortcuts, but that’s a very bad decision.

We can help here. We encourage you to take advantage of the free consultation with one of our factoring specialists. Our years of experience in this industry have positioned us as a leader, and enabled us to deliver outstanding solutions to our clients, pairing them with the right factoring partner based on their unique needs and requirements.