Factoring remains one of the oldest types of financing dating back to the Babylonian era.
This type of financing helped traders to continue to buy and sell inventory in good and bad business times. In the modern era, the commercial banking industry has viewed factoring with a negative connotation. However, this perception has quickly been changing over the last few years. Today, factoring is one of the fastest ways to create a stream of capital to both growing and struggling companies, without the restrictions that a traditional bank line of credit may require. So what are 4 specific reasons companies use factoring? Read below to find out.
Here are the Top 4 Reasons Why Companies Use Factoring:
Factoring helps kick start liquidity. It is one of the best financing options for currently unbankable businesses that are struggling, in start-up mode, undergoing an acquisition, or growing quickly. This type of financing helps companies to obtain immediate working capital that kick starts liquidity, generating positive cash flow and results.
Factoring helps companies create fluid funds by selling their accounts receivable. Thereby creating sufficient working capital to purchase new inventory, hire employees, make payroll and meet other expenses required to operate and grow the business. In many ways, factoring can act as an insurance policy so that payroll and other obligations can be met quickly, alleviating cash flow pressure.
Factoring does not usually have financial covenants. If a bank sees a blip or temporary decline in financial performance, the business may be thrown into default due to failure to meet covenants. Thus, hurting or virtually destroying the company’s liquidity due to forbearance or default fees, along with more restrictive lending requirements. This forces the organization to seek other financing during what is already a difficult time.
Here is where factoring can help. While financial performance is important, factoring companies tend to place most of their due diligence on the performance of the company’s accounts receivable. This helps to create a positive money stream generated during these tough times. Owners can then focus on running their company instead of being worried about their bank line of credit being in default.
Factoring is a fast solution for working capital. Factoring companies can typically make fast decisions where a company can be approved and funded within under one week. Unlike a traditional bank loan that may take several months to be approved and close. Many growing companies need money immediately in order to capitalize on current opportunities. They do not have time to go through the bank approval process and therefore need another option. With factoring, the company will also be able to receive funding the same day they generate new invoices. This keeps them focused on progressively providing products and services.
Factoring can help mitigate losses and reduce operating expenses. Factors will help business owners review credit on new customers and monitor the credit and payment trends of existing customers. This helps business owners stay informed and know what is occurring with their customer base. It gives a business owner peace of mind so they can focus on the day-to-day operations, especially when selling to new customers while growing their business. Moreover, factoring companies help with collection calls or checking on payment status, and some factors work in tandem with the company’s existing back office to aid in these efforts. Any collection note or invoice activity can usually be seen through an online portal. Most good factors will also provide images of payments received, as well as online reporting that allows for full transparency of fees and account status as part of the services covered by the factoring fee.
Companies that currently do not qualify for traditional bank financing think that factoring is a brilliant way of generating liquidity. Factoring has come a long way, with more and more companies using a factor’s services for funding their receivables, maximizing their back office services, and for reporting tools. Perception may be everything, and fortunately, the perception of factoring continues to change for the better.