4 Important Questions Your Customers May Have About Factoring

Factoring Customer QuestionsBusiness owners often have many questions when it comes to factoring, since it is a form of financing that is unfamiliar to many. They want to understand the practice and how it will affect their business now and in the future.

Being prepared to answer their important questions will help you make them comfortable with factoring and more likely to want to do business with you.

Will factoring work for my industry or specific business?

Factoring is a viable financing option in many industries, including manufacturing, medical, construction, oil and gas, temporary staffing, trucking and freight, technology, and clothing and textiles. While each industry has its own challenges, they tend to share commonalities which make factoring possible:

  • Creditworthy business customers
  • Longer credit terms (30 to 90 days)
  • Higher invoice amounts
  • Sound business practices
  • Higher profit margins (usually 15% or higher)

Of course, not all businesses within a specific industry are good candidates for factoring. For example, factoring works well for companies that provide services or products mainly to other businesses. Those businesses that mainly serve consumer normally do not have the credit terms necessary for factoring to be a viable option.

Another issue may be the average size of each invoice. A business may send out numerous invoices per month for very small denominations. Many factors assess fees to review each invoice for risk. These assessment fees, for so many invoices, may make factoring too expensive.

Some businesses run on a tight profit margin. They depend on volume to keep the company in the black. Factoring can involve fees up to 8% of the value of each invoice. Companies with tight profit margins may find factoring takes up too much of the profit margin to be a viable financing option.

How many of my invoices should I factor?

The answer completely depends on the customer’s needs/desires and the arrangement they have with the factor.

Some customers like being able to turn over all of their invoices each month. It puts payment processing and collections in the hands of the factor, relieving them of most of their A/R responsibilities. These customers like being able to outsource that function while gaining the cash flow that factoring provides.

Of course, other customers are not so giving when it comes to factoring invoices. They want to maximize their cash flow; and minimize the fees. Those customers often choose to factor their largest invoices, while keeping their smaller invoices in the regular invoices/pay cycle.

The arrangement also influences the number of invoices a customer factors. Most arrangements are based on a minimum amount factored each month. If the customer does not factor that amount, fees may be higher. However, if the customer factors a higher amount, fees may go lower. Fees can also be influenced by the length of the arrangement. A longer contract usually comes with lower fees than shorter ones.

Isn’t factoring just a bank loan?

While factoring has been around in some form since ancient times, it is a type of financing many business owners are not familiar with. That is one reason why factoring clients often think factoring is just another kind of business loan. Yet, they are quite different.

  • Banks will not loan money unless they consider the risk low enough. Factor agencies will work with many businesses that banks refuse to lend to.
  • Banks require businesses to have good credit, a solid financial history, good sales trends and plenty of cash flowing. Factors want to know that invoices are valid and the customers tied to those invoices are creditworthy.
  • Banks can take weeks or months to approve a business loan. Factoring is much faster. The initial set-up usually takes a few days to complete. Once set-up, the client can get an advance within 24-48 hours of submitting invoices for factoring.
  • Bank loans are not flexible. When bank lends a certain amount of money, they expect that money paid back over time at a certain rate of interest. To get more cash, the business will need a new loan. Flexibility is built into factoring line of credit based on sales volume. It is not a loan. The client can choose which invoices to factor in any given month, depending on what their cash flow needs.

I have bad credit/back taxes/no money – can I still factor?

Small businesses and start-ups often face issues that make it impossible for them to get bank loans or lines of credit. It may be the business has no credit rating of its own. The owner may have bad personal credit. The business could have cash flow issues making payments late and lowering the credit rating. The lack of cash flow means little to no money in the bank to meet basic expenses. Poor cash flow can also lead to problems with back taxes.

Can a business factor with these problems? The answer is, in many cases, yes.

  • Factoring does not depend on the credit rating of the business or the owners. It is largely based on the creditworthiness of the customers attached to the invoices. The factor will consider how the business is run and will run credit reports to verify information. But, it does not count as much as customer creditworthiness does.
  • Little to no money is very common with businesses looking at factoring. In fact, their goal is to improve cash flow with the help of a factor. The factor will look at how the business is run to ensure it has sound business practices. Lack of cash normally is not a big deal.
  • Back taxes are a bit trickier. When a business owes taxes to the state or federal government, tax liens are a common security measure. These liens are often attached to any and all assets owned by the business, including accounts receivable. Without those invoices, you have nothing to factor. In some situations, the IRS will agree to allow factoring to raise money to pay off the lien or continue installment payments. It really gets down to a case-by-case basis and how comfortable the factor is with the situation.

Your customer needs to be comfortable with factoring before he or she will even consider it for improving cash flow. The answers you provide to their questions will make all the difference.

What other questions have you heard from your customers?

About the Author:

Dieter Gatley is Business Development Officer of Factor Funding Co. They increase cash flow for small businesses by providing receivables factoring, asset based loans, equipment financing and many other services.

 

Comments

  1. Splendid article. To reinforce the last point, some business are locked in a viscous circle with inflowing and outflowing cash.

    It’s best to imagine it as a boat with a hole leaking water inside. You have a bucket big enough to scoop it out, but you can’t get rid of all the water that came in before you grabbed the bucket.
    Factoring is like having a bucket three times the volume, but it too has a tiny hole and water leaks out.

    If you scoop hard and fast enough, the bigger bucket will always help you stay dry. If you take too much time to pour water out of your boat, the hole will leak enough water, so you start flooding again.

    As with any finance, caution is advisable at all stages of the deal. Financial providers will always prioritise their gain before yours.

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