Small businesses may benefit from engaging in factoring their receivables. Small business factoring does have a very real cost associated with it, but also comes with some fairly significant advantages which can yield significant benefits for a company. Here are some of the considerations to have when looking into small business factoring.
What is Factoring?
A factor is a company that assumes the
collection risk associated with a receivable in exchange for a
portion of the outstanding invoices. There are many variations to the
arrangement that exists but the typical arrangement starts with some
basic due diligence on behalf of the factor.
The factor will
examine the nature of the sales that the small business has and
examine the history of the customers that they sell to. Typically
speaking, most factors will focus on businesses that sell to other
businesses, but businesses that sell in large quantities to
individual customers may have their receivables factored as well.
However, factoring is not typically done for small individual
transactions such as retailers or restaurants.
Many factors will assign a collection risk to various receivables and then assign a factor fee in exchange for collecting the receivable. On an annual basis, this factoring rate will be adjusted as need be. A factor will charge the small business the fee as a percentage of the receivables transferred and will pay the small business for the entire balance of the receivable balance less the factoring fee. Some adjustments are sometimes made for chargebacks and other customer discounts but the factor will assume the overall collection risk in exchange for the factoring fee.
Reliable Cash Flow
One of the biggest advantages for a
business that uses a factor is the reliable cash flow that a factor
provides as well as the comfort that the factoring relationship
offers. With a business factor, the company can be sure that they
will collect the entire portion of their sales, less the factoring
fee, and can, therefore, keep themselves from being susceptible to
losses from bad debt.
As a result, small businesses that have
a large concentration of receivables from a particular customer can
often survive even if the customer defaults on the payment due to
bankruptcy. Further, the small business can rely on the cash flow
coming into the business on a regular basis in order to cover their
payroll and other expenses without having to constantly fight to
collect receivables.
Reliable cash flow is essential to businesses that are looking to invest in their business via expanded staff and asset investments. Factoring provides a predictable cash flow that can help to allow them to make these investments without fear of having the cash to pay for the investments as they will receivable a reliable and predictable reimbursement for their sales.
Distraction for their Staff
Collecting receivables can be
challenging and often involves hiring a collection staff member to do
so. Hiring an internal staff member may not be economical for small
businesses, but even if it is, many companies will need to involve
management and executive support to assist in the collection process.
This can lead to a major distraction for the staff and
management of a company that becomes distracted from growing their
revenue and operating the business effectively. Factoring helps to
prevent collections from becoming a problem and a distraction as well
as a point of tension with customers and allows small businesses to
focus on executing growth and their business strategy.
Factoring receivables are not appropriate for all businesses but can be an effective option for many small businesses. A small business should consider the unique advantages associated with factoring receivables and determine if it is the right choice for their business model.