Everything Business Owners Should Know About Factoring
No business owner wants to worry about meeting their financial needs, yet sometimes it is hard to get access to capital quick enough to meet immediate needs. Some business owners resort to factoring accounts receivable from customers who have not yet paid them off. While this method of financing can be beneficial, there are important steps you need to know if you’re considering going to a factor.
First, factoring can get you cash in a quick manner. By selling an invoice to a factor company, you’ll be paid for most of its value upfront. This can help if you’re in a pinch and need to meet payroll or make other payments in a hurry. However, how much you’ll actually receive upfront depends on who the customer is. If your accounts receivable is from a large customer, such as a big box store or a nationwide retail chain, the factor company is more likely to forward you a greater cash amount.
You should also ensure that your relationship with the factor is short-term. Your goal is to finance your invoice. Once that’s done, your business is concluded. Make sure that your contract does not include a long-term relationship with the factor company. Your relationship can also be dragged out if your customer is very slow in paying the invoice. The annual percentage rate paid to a factoring company is reported to range anywhere from 12% to 60%. Too much time waiting for payment can result in you paying out more interest. Also be aware of any possible hidden fees in your contract. Fees will likely vary across factor companies. Read the contract closely.
Also be sure your arrangement with a factor company does not harm your relationships with customers. For example, your agreement with the factor may end up communicating information that your customer does not want revealed. Your factor will also want to know whether your customer is creditworthy and is able to pay the invoice. If the factor investigates your customer too aggressively, your customer may refuse to deal with you again. A factor company could want customer checks to be made payable to itself and not your business. Your customers may be concerned about suddenly having to pay another party. It would be advisable to negotiate a different payment strategy.
Factoring can bring its share of risks, and it may help to examine other alternatives before making a decision. By understanding what to expect, a business owner will be informed enough to make the right financial choice.