Many professional advisors and consultants – including CPAs and Bankers – are sometimes hesitant to recommend accounts receivable financing aka factoring to their customers. The problem is that many misconceptions exist concerning this option, so lets look at the top two.
Myth 1: Factoring is too expensive
In reality, factoring – the sale of accounts receivable or invoices at a small discount to obtain immediate cash – is a cost-effective way to get funds for your business. Company owners should understand that the most expensive form of capital is equity. Raising additional equity to finance new growth or meet working capital needs often entails giving up a portion of ownership, and that is terribly expensive. Using factoring to fund new growth normally entails a slight reduction of profit (usually 1-3%) that’s comparable to vendor discounting and generally outweighs the alternative of not taking on new business. Many companies see it as offering their customers a discount to pay early and getting all the bells and whistles that come along with the factoring service.
Myth 2: Factoring is a sign that my business is weak
Factoring is actually a way for businesses to prepare for a stronger future. Factoring can improve a company’s credit rating, provide cash to meet obligations and does not create debt on the balance sheet. Many companies take advantage of pooling their own invoices and selling them together in order to generate cash. Essentially this is a version of factoring.
Turning over accounts receivable management and funding to an outside financial service has other advantages. Factoring can eliminate a lot of frustration for business owners who struggle to collect payments on time. In addition, factors can work hand-in-hand with a company’s CPA or other professional advisor to help provide credit checks on prospective customers, product validation, A/R collection and cash management.
As companies review their financial forecasts and prior activity, many find they do not have enough working capital to address exciting new business opportunities that come their way during an economic recovery. Some are young, growing companies that do not have the history to support traditional bank financing. Others may no longer qualify for traditional bank financing because of previous quarterly or annual challenges. The solution may lie in seeking alternative solutions for funds.
Factoring is flexible, accessible, produces fast results, and doesn’t require businesses to commit to a long-term program. The bottom line: Factoring can provide a winning solution for companies experiencing growing pains.