The term “Factoring” has gotten a bad reputation in the world of small business credit over the years. The question is why does the oldest form of financing conjure up such disdain? Maybe because factoring is misunderstood. Let’s try to set the record straight and educate business owners why factoring is a great solution to their cash flow problems.

Many small business owners view factoring as financing of a “last resort” and worry about what their employees or customers will think about the longevity of the business once they learn their employer/supplier has entered into such a financing arrangement.

While business owners should be concerned about how their customers perceive their business, entering into a factoring arrangement is rarely the “red flag” many fear it will be due to the fact factoring has become a much more common means of providing a company with access to working capital.  The odds are excellent many of your customers are already familiar with factors as so many suppliers are taking advantage of this valuable financing tool.

Since access to business credit has obviously contracted over the last few years, it has become more challenging for small businesses to obtain business credit lines.  Many lenders reserve secured or unsecured business lines of credit for only their “best” customers, which are often defined as those who have strong profits, increasing revenue trends and high balances on deposit.

Factoring can be a convenient alternative to businesses which cannot meet today’s stringent criteria for small business loans but have a strong base of customers.  Under most factoring arrangements, the factoring company ignores the financial condition of the client and strictly focuses on the credit quality of their customers.

If the customers are creditworthy, there is an excellent chance a factor will be interested in “factoring” the accounts receivable.  When factoring a receivable, a business sells or assigns the right to be paid by their customer to the factoring company in order to receive the bulk of the amount due (usually 85-75%) shortly after issuing the invoice, with the balance, less a factoring fee, remitted to the business once their customer makes payment to the factoring company.

Fees can range from 2% – 5% of the invoice amount for each 30 days an invoice is outstanding.  In other words, if a customer typically pays their invoices in about 40 days, the business would take on average about a 3% discount on their invoices in exchange for the factoring company advancing 85-75% of the invoice amount shortly after it is issued.

Like any industry, there are also unscrupulous factoring companies out there.  It is important to ask for references and to Google the name of the factoring company you select to see what, if any, complaints are out there.  Many factoring companies are run by long-time veterans of the business and are often the best choice with which to develop a financing relationship.

Stop thinking about factoring as a dirty word and instead think of factoring as the working capital bridge needed until you can meet the standards for traditional business credit lines.