Factoring 101 Challenge #2: Why Would a Business Employ Factoring?

If a small business cannot, for whatever reason, access a traditional working capital loan at a local bank, that business owner will need to seek out non-traditional capital sources or close its doors.  For those companies operating on a B2B basis, one of the world’s most popular methods of raising capital is to “release” the existing working capital trapped in the company’s invoices.  And the financing mechanism of choice to do just that is accounts receivable factoring.

One of the earliest hints that a company is about to need factoring is when a weekly or bi-weekly payroll becomes difficult to meet.  Often, a business owner will need to do something as critical as borrowing against a company (or personal) credit card just o be able to cut checks or even worse, tell employees they need to wait a few days before cashing their payroll checks.  Factoring can often completely eliminate this problem.

The need for factoring is usually the result of an inability of a business to access traditional bank loans or lines of credit, a trait that is of even greater importance during periodic times of economic downturn.  So it is really no surprise that modern business owners are becoming increasingly more aware of factoring as a ready form of alternative commercial finance and one which can be employed quickly in times of cash flow and working capital crisis.

From a technical financing standpoint, and as you now understand, factoring is only utilized to address the cash flow problems caused by extending terms of payment to customers and the working capital shortfalls such extensions can ultimately create.  Shortages of working capital can result in serious problems for business owners who will then seek out some financial option as a remedy.  Problems associated with working capital shortages which can drive a small business to seek factoring include:

The entire list of reasons for a business to utilize receivables finance and establish a factoring arrangement is fairly expansive.  In most cases, however, savvy brokers and consultants know working capital shortages will tend to first appear when cash is in short supply for the timely payment of salaries to employees and that will start this list which includes…

  • PAYROLL:  Shortages of cash when payroll is due are by far the most common reason for a business to seek out the services of a factor.
  • SUPPLIER PAYABLES:  Making timely payments to suppliers or also being able to take discounts for early supplier payments.
  • TAX OBLIGATIONS:  Especially payments associated with employee 941 payroll taxes.
  • EQUIPMENT:  Raising cash through the sale of invoices to purchase equipment when leasing is not an option.
  • INVENTORY:  Purchasing inventory when other forms of lending are not available.
  • MARKETING:  Expanding and increasing marketing operations.
  • BUSINESS EXPANSION:  Raising capital to enter new markets, buy out a competitor, or other forms of business expansion.
  • INVESTMENT OPPORTUNITIES:  Raising cash for an investment opportunity such as buying a building or purchasing an additional franchise.

One reason why experienced factoring brokers and consultants focus much of their business development efforts on payroll intensive services related prospects such as staffing companies, guard services, janitorial services, landscaping companies, etc., is due to their typically large payroll responsibilities.  These are businesses that tend to have an abundance of employees and sizable weekly or bi-weekly payrolls. For brokers, they can represent “low hanging fruit” for prospecting  and as you will eventually learn, such small service companies with an abundance of employees are a great place to start marketing and can form the backbone of your consulting business.

Another common problem that drives business owners to factoring is when a small business enterprise is fortunate enough to be awarded contracts or orders for goods and services from large customers.  This relationship of small company getting business from large company that demands extended terms is a well-known and recognized and common cause of a small business owner to reach out and arrange a factoring relationship to cover payroll and costs associated with the new customer.