You work hard competing against changing markets, bigger competitors and a thousand other obstacles facing small business owners. Then one day, it happens; you get that big order. All the sales presentations paid off, because you now have an invoice for 1,000 units.
The only problem is, you’ve never produced more than 100 units in that time frame, and the extra people and materials needed will cost more than your credit will allow, and the customer is notoriously slow paying. Combined with all the other outstanding accounts, you have invoices for all the money you need to continue operations. The problem is most of it won’t come in for another 90 days. Factoring may be the answer.
“Factoring is a method whereby a company will present an invoice to a factoring company, which will advance them money against that invoice,” says Charles Grimley III, president and CEO of Cherry Hill, NJ-based Grimley Financial.
For example, an invoice for $10,000 presented to a factoring company could mean a $7,000 or $8,000 immediate advance, depending on how the fees are set up. The factoring company is then responsible for collection of the invoice.
“Factoring provides immediate working capital to businesses, thus allowing them to meet expenses on a timely basis and to purchase raw inventory for production,” says Grimley. “Factoring typically manifests itself through slow-paying receivables. If all clients paid on net 10 days, there’d be no need for factoring.”
Some businesses, especially those organized as Sub-S corporations, may have trouble obtaining bank loans because of poor earnings or a previous derogatory credit problem. Factoring may be the only option in these situations.
Factoring fees are determined by:
- The type of industry being factored
- The dollars factored per month
- Degree of credit risk
- Credit history
- The amount of money being advanced.
Fees typically range from 10 to 40 percent of the total amount.
“Factoring is mostly still a viable alternative for manufacturing companies, but there are more companies in the service sector that have had to consider factoring as a financing alternative due to a slow-paying customer base and banks that are unwilling to lend to small businesses on an unsecured basis,” says Grimley.
Factoring is obviously more expensive than conventional financing, and some factoring companies require customers to factor on a monthly basis or on a predetermined threshold of receivables. But the money made available may also help you save money by purchasing supplies in larger amounts to achieve greater per-unit savings. Some companies will consider factoring money on a purchase order, allowing the company to use the money to buy the initial raw materials needed to fill the order.
