Invoice Factoring: No More Missed Opportunities

For companies undergoing rapid growth, financing is a major concern. Many CEOs look first to equity and debt financing, but there’s another option that may be preferable in some cases.

Factoring is a finance technique that enables a company to transfer the credit risk of their accounts receivable to a third party and leverage the accounts receivable to accelerate working capital.

If a company has the expertise and market demand needed to expand – but lacks the capital to seize expansion opportunities – factoring is often ideal. Factoring allows business owners with working capital constraints to fill larger orders and bring their products to new customers.

Factoring gives business owners the financial freedom to create a backlog of orders or work which opens more doors for their business, creates consistent streams of revenue, and improves their balance sheets.

Common Misconceptions of Factoring

One of the most common misconceptions of factoring is that companies that use factoring services have financial problems. This is not the case. Our clients use factoring to amplify their strengths and take their business to the next level. Under Dodd-Frank, a financial reform act, most banks are restricted from providing credit to smaller companies. In many instances, there are no alternatives to factoring for companies with sales of less than $20 million. At Capstone, we focus specifically on companies who have been disenfranchised by this legislation.

How it Works

Factoring can be used by a wide variety of businesses, including staffing companies, product distributors, licensees, manufacturers, sales organizations, service companies, and importers. A factor gives a business a cash advance on their customers’ invoices — usually between 70% and 90% of the invoice amount. Even the most efficient businesses struggle to make ends meet while waiting the 30 to 60 days for an invoice to be paid. This is especially true for larger orders. Factoring allows a business owner to receive the proceeds from a large order in 24 to 48 hours, keep up with demand, pay their employees and fulfill new orders as soon as they come in.

How Does Factoring Impact Your Current Financial Solution?

CEOs often ask us whether factoring can replace their existing financial solution. Factors can replace banks, or work with them as an additional funding resource. It all depends on the business and their unique situation. Often, small businesses have a very limited line of credit with a bank and very little flexibility to obtain financing outside of that line of credit. A factor can enter into an arrangement with a client’s existing bank in order to purchase account receivables and work with the bank to help the client grow.

Banks like working with factoring companies because it improves the client’s financial standing, which in turn increases the likelihood that the client can stay in good standing with the bank. Further, as the client’s balance sheet grows, the bank can increase the amount it lends to the client.  Factoring is a responsible, low-risk tool that allows businesses to improve their good standing and fund profitable operations for long-term growth.

Questions to Ask a Factor

Here are a few things to look for in a potential factor:

• Who is responsible for paying the factor back? A factor will usually offer a non-recourse program in which the business owner receiving the factor advance is not responsible for paying the factor back. The client’s customer (who is responsible for paying the invoice) pays the factor.
• Is a multi-year contract required? Some factors require clients to commit to financing a minimum amount of invoices for a given period of time. This is called a “factoring minimum.” Look for factors that do not require multi-year contracts (Capstone, for example, has a single invoice factoring program available for “only when you need it” factoring).
• Whose credit does the factor evaluate to make credit decisions? The client’s creditworthiness is less important to the factor than the creditworthiness of the client’s customers; the client’s customers are the ones paying the invoices. By funding against sales, not a balance sheet, a factor allows the client to grow as fast as their product or service is accepted in the marketplace.
• Do they understand how your business works? Look for a factor who understands the day-to-day challenges of running a business and balancing multiple priorities (e.g., rent, payroll, taxes, employee issues, vendors, etc.) Is the factor willing to look at your challenges in a holistic way and provide support to help you grow your business sustainably?

Is Factoring the Right Fit?

The ideal candidate is a company that has expertise in their chosen field and is growing faster than their balance sheet will allow.  But it’s worth remembering that every business gets a limited number of big opportunities. It’s companies that are prepared to hit the ground running that make the most of them.