Many businesses have problems collecting on their outstanding receivables or are looking to develop more predictable cash flows and turn to business factoring as an alternative. Understanding what business factoring is and how it can help a business to grow and prosper is essential when determining if this is the right solution for a business given their economic climate and the situations surrounding their business model.
What is Business Factoring?
A business factoring arrangement is one in which a third party factoring company will assume the collection risk and processes surrounding collections in exchange for a percentage of the outstanding receivable. The exact rate will depend on several factors, as outlined below. A company that uses a factor will receive the full value of their receivables, less the factoring rate, which can increase based on the risk associated with your customer base and the length of time the receivables are outstanding. A business will need to transmit data to the factor surrounding the receivables and invoices and provide data to assist the factor in collecting the outstanding receivable balances.
What is the Cost of a Small Business Factoring Service?
There is no universal cost associated with business factoring. The rate that is charged by a business factor will depend on the line of business of a company as well as the credit ratings of its customers. For example, if a business sells to large multi-national companies there is typically a lower factoring charge than for a business that is selling to small mom and pop businesses which pose a greater collection risk. A business factor will calculate the collection risk that they identify is associated with your accounts and will add on a profit margin for their role as a factor, and will charge the business this rate on its sales. This factoring cost represents lost revenue for a business and can limit its ability to grow as a result. If a business collects a significant amount of its receivables, than using a factor can be an unnecessary expenditure for the company.
Some factors will need to verify and perform background checks on some customers, due to the credit risks that they pose. As a result, a business will not be allowed to sell to these customers unless they do so outside of the factoring arrangement, which can confuse your business processes and lead to the need to add additional headcount of running the company.
What are the Benefits of Business Factoring?
When a business signs up for a factoring service they benefit from a simplified reporting structure and processes. Most businesses that use a business factor will get rid of their internal collection staff and will use the factor to process their collections. As a result, a company using a factor can operate with a smaller headcount and sales personnel and management can be more focused on servicing their customers and growing their business, and not have to worry about collections and cash flow, which can be a significant distraction for many businesses.
A business that uses a factor can benefit from avoiding large disruptions when a large customer does not pay an outstanding bill or series of bills and gets some relief from bad debt and uncollected balances as a result. A company that utilizes a factor is also able to better plan out their cash flows and use their cash balances more efficiently as they know they will be able to collect on their receivables from the factor. Solid and predictable cash flow is a significant benefit from a small business factoring service that cannot be understated.
Factoring is not the right option for all businesses but can be a viable alternative for companies that are looking to put together a solution for their outstanding receivables and to simplify their operations going forward. A business should look into the costs and benefits of factoring arrangements and carefully weigh these items when determining if business factoring is the right solution for them.