For small- to mid-sized businesses, a traditional way to get more financing is through a business loan. If you need more capital to expand to a bigger warehouse or hire five more computer engineers, isn’t a loan the best way to do that? What many business owners don’t realize is that there are other options out there for increasing cash flow to expand and grow a business. Here’s a look at what loans are and how they help small- and mid-size businesses, and then what factoring is and how it might help businesses in a different way.
What Is a Business Loan?
Most people understand the basics of how loans work, but here’s a basic list of the process you go through in order to secure a loan for your business:
- You apply for the loan.
- The bank or lending institution evaluates your business’s creditworthiness to determine how much they’ll lend and at what interest rate.
- As part of the credit evaluation process, you’ll have to provide financial statements, credit reports, and tax documents for your business. This process can extend over several months.
- The bank comes to a decision and, if they decide to loan you the money, they present the decision to you. Funding is capped by the amount the bank is willing to lend, whether you were hoping for more or not.
- If you agree with the loan terms, the funds are then released to you.
This is a pretty arduous process, and start-ups often have a hard time getting loans because they don’t have the financial history that proves their creditworthiness. This is seen as a risk that banks don’t want to take on.
When Is a Business Loan a Good Option?
Business loans are a good way to go if your company has had time to prove itself as stable and has good credit. On top of that, it’s a good option if you have a specific need, you know how much money you need, and you see how having that money will benefit your company over the long run. It’s a long-term type of investment that is best done with a business plan that includes a profit analysis report and projections.
What Is Factoring?
What factoring first and foremost isn’t is long-term debt. That’s huge! Factoring is not borrowing money that you don’t have. Instead, you’re opening a line of credit equal to the amount of your open invoices. This is money that you’re already slated to receive, but rather than waiting for your clients to pay those invoices, you’re taking control and getting that money now.
You’ll get up to 85 percent of the open invoices you have now and then the rest once the invoices are paid by your customers, minus fees to the factoring company for their service. Some of these fees are charged monthly, so the sooner you’re paid, the more you get to keep.
What Are Advantages of Factoring?
There are many advantages to factoring, but one of the biggest is time. Where a loan can take months from start to cash in hand, factoring gets you money in as little as 24 hours.
Another advantage that you can get from factoring that you can’t from a loan is unlimited funding potential. Where loans are limited to what the bank is willing to provide, you can factor all your open invoices. This opens up your company to unlimited potential. And unlike loans, this funding is based on the credit of your clients rather than your own company’s credit. Since you don’t need extensive credit history to access factoring, start-ups and experienced companies alike are able to take advantage of invoice factoring.
When Is Factoring a Good Option?
The first question you want to ask yourself when you’re trying to decide whether a loan or factoring is a better option is when do you want your money? If you responded with now or soon, then factoring is the right option for you.
Factoring is great for those that need flexibility when it comes to funding. Where loans can take a while to procure, factoring can be used whenever it’s needed. Maybe you have a big bill coming due and you realize you don’t have enough liquid capital to pay for it. Factoring could you get you through that payment so you don’t default and harm your business’s credit. Or maybe you don’t have enough funds to cover payroll. Factoring gets you money fast, so your loyal and hardworking employees don’t suffer.
In the end, factoring is a great way to control the cash flow of your business without worrying about when your customer will pay. All you’re doing is getting assets you’ve already secured. You’re just getting them sooner.
What Are the Disadvantage to Factoring?
One thing you should realize about factoring is that you are responsible for that money if a client fails to pay a factored invoice. For that reason, you want to ensure that you only factor the invoices of reliable clients who are likely to pay. If you have a longstanding relationship with that client and are paid regularly and completely, you have no reason to worry.
In fact, the factoring company will, as part of its services, provide a credit analysis of all customers and potential customers. This is a big advantage for small businesses that don’t have the ability to do these analyses themselves. Companies can take advantage of that and use it to determine if they should go into businesses with these customers.
Overall, when it comes down to it, factoring and business loans have their place. It all depends on what kind of financing your company is in need of and what you’re hoping to achieve. But if you’re looking for quick financing to help with an immediate need, factoring is definitely a great way to go. Have questions? Contact FSW Funding today. We’re happy to help you understand how factoring works and how we can help you out!