Invoice factoring, also known as accounts receivable financing, is a form of asset-based financing.

Everyone is familiar with bank loans, which are a primary source of business financing. Banks and other providers of traditional funding options analyze a company’s income statement, balance sheet, etc., to establish the value and creditworthiness of the company. The amount of credit and the terms offered by banks will depend heavily on the information derived from the financials such as the ratios of profitability, debt (leverage), and liquidity. The better a company looks on paper the more likely it will be approved for the desired amount of credit and under favorable terms.

what is factoring

Instead of focusing on the potential “success” of a company, which a bank defines as the ability to repay the loan plus interest, asset based lenders are interested in the value that already exists within the company.

Asset-Based Loans

The easiest example of an asset based loan occurs when a company puts existing inventory up as collateral. The process here is simple:

  1. A company has inventory but no cash.
  2. An asset-based lender will advance a sum of money based on the liquidity value of the inventory (collateral).
  3. If the loan falls into default the lender takes control of the stated collateral.

Of course, banks like this idea of collateral to secure the loans they make as well. The main difference in this case is that banks still make their decision based primarily on financial statements and asset-based lenders look more at the liquidity of assets, meaning asset-based lenders will typically monitor the collateral much more closely than a bank will.

A/R Factoring

Accounts Receivable Factoring works a little differently than the example above because the financing firm essentially buys a company’s invoices.

Invoice factors can advance a percentage- say 80 percent- of outstanding accounts receivable to the company in 1 or 2 days. The factor then becomes entitled to collect the accounts from the third party debtors.

The 20 percent of the invoices not paid to the invoice seller is referred to as the “reserve,” which factors hold in order to limit potential losses from bad debt, etc. When an invoice is paid in full the factor’s fees are subtracted from the amount held in reserve and the remainder is returned to the client. Of course, the fees will vary based on a number of variables, but Universal Funding offers rates that begin as low as .55 percent. (If you are currently factoring and paying over 2 percent, contact us!)

Invoice factoring can be more effective than short-term business loans in raising immediate working capital especially for small and/or riskier businesses. Companies that factor invoices increase their cash flows without incurring more debt. This allows such companies to pay their liabilities in a timely manner, increase production, expand operations, and become more profitable. Factoring is certainly a growing sector of the financial industry and can be advantageous for many businesses in the current economy.

How is Factoring Different?

Smart and savvy business owners search online for information and funding sources before running down to the closest bank and applying for a loan. Search online for “small business loan” or “business financing” and you’ll find a slew of banks, government agencies, consultants, middle-men and fly-by-night quick cash operations.

A term that doesn’t usually come up in the business loan search is “invoice factoring.” Not many business owners have ever heard of factoring, even though it’s a legitimate and long-standing finance tool. If you need a quick rundown of the factoring process, give this article a quick read.

Factoring companies gained more recognition and loyalty during the recession when banks put a stop on the free-for-all lending practices of the past decade. Many small and medium-sized businesses rode out the recession, even managed to grow, thanks to factoring. Now that traditional credit financing is beginning its come-back, the savvy business owner should consider all options, including factoring.

Here’s a quick look at how traditional bank loans compare to invoice factoring.

Time in business: 

Bank loans typically require a minimum of 3-5 years in business while factoring is commonly used by both start-ups and established companies.

Required documentation:

Applying for a bank loan requires a business plan, three years of financial history, three years of business tax returns and personal tax returns along with current personal financial statements. A factoring company will want to see your balance sheet and P/L report, last year’s tax return and a current A/R aging report.

Ratios examined: 

A bank will review your liquidity, leverage, inventory, turnover, receivables turnover, gross profit margins and return on sales. A factoring company does not review typically review ratios.

Credit ratings: 

Banks won’t give many loans to businesses with less than a stellar credit ratings. Factoring companies look at the credit rating of your customers and doesn’t pay much attention to yours.

Use of funds: 

Banks can require that the funds they provide are allocated for certain uses (inventory, equipment, etc.) Cash from a factoring company can be used however is best for your business; there are no limitations.

Approval time: 

Approval for a bank loan can take months while getting approved for factoring can take a couple of days.

Repayment of funds: 

Banks require a monthly payment for a set term to repay the borrowed funds. Factoring is a process that does not incur any debt for your business, meaning no payments- ever.

The Many Benefits of Invoice Factoring

You might wonder, besides getting money right away, what else a factoring company can do for you.

If you’re working with a limited service factor the answer is, not much!

However, Universal Funding is a full-service factor and offers a wide range of services that can be tailored to meet your needs.

A limited service factor typically will not do much more than buy your invoices and collect the money. However the benefits offered by a full service firm like Universal can help any company become more successful.

Perhaps the biggest benefit achieved through invoice factoring is establishing a schedule of predictable cash flows. Cash runs business, every one knows that, and being able to rely on a consistent source of money keeps you productive.

It is hard to do business while waiting for money to show up. It is even harder when you don’t know when, or if, it ever will. Factoring can help companies build more accurate budgets and keep projects on schedule. More cash can increase purchasing power with suppliers, increase production, purchase valuable business assets and much more.

The value of reliable cash flow alone is worth the nominal factoring fees, but start adding the value of the additional services and you will definitely get more than your money’s worth!

First of all, remember that Universal Funding works for you! Our goal is to get you your money faster and works hard build your success.

Many banks, on the contrary, are really only interested in your ability to make payments on the loan. Actually, since the loan is most likely secured with some kind of collateral they may care little if your company actually prospers or not.

We, on the other hand, want your business to increase.

Universal Funding can even offer complete oversight of your company’s accounts receivable department. This can include everything from billing, follow up, and collections. This service can be especially useful for small and midsize businesses that usually do not have a dedicated A/R department, staff, or even person. Small business owners and managers wear a lot of hats and having to allocate time for managing customer accounts can be distracting to say the least.

One of the biggest lessons in business school is to stick with your core competencies- do what you know and do best and get someone equally knowledgeable to do the rest. Factors have the expertise in this department; out-sourcing the receivables department reduces costs and wage expenses and allows the company to focus on its bread-and-butter business operations.

In contrast to a bank loan with the interest and fees that go along with it, factoring is a much better value. Instead of paying a bank for the privilege of borrowing money from them- only to be harassed for interest payments- factoring fees include additional services from people genuinely interested in you and your company. Universal Funding keeps companies moving forward by relieving the worry associated with sporadic cash flows.

In short, factoring is a finance tool that grows along with your business and provides debt-free cash when you need it. Business loans certainly have their place, but wouldn’t you rather finance your business without going into debt if at all possible?

If so, fill out and submit our no-obligation rate inquiry form and we’ll be in touch!