For new commercial finance consultants and, as you will learn, factoring is not only one of the world’s most straightforward forms of commercial finance, but it is also one of the most easily accessed. As an independent broker/agent, you will need to explain factoring and its unique method of solving cash flow problems to business owners and others. Suppose you are a new agent or business finance consultant entering the field. In that case, this short article will help you better understand factoring as you progress and gain more product knowledge that you will require to truly assist small business owners in solving their financing problems in today’s challenging economy.
First: Factoring vs. Lending
Business owners can employ dozens of loan types and financing methods when seeking to finance their business. Some are easier to secure than others, depending on collateral and credit. For example, standard term loans are available from local community banks, revolving lines of credit from banks and asset-based lenders, specialized floor plan financing for distributors, and a host of loan products with specific uses affiliated with loan guarantees from the SBA (U.S. Small Business Administration). Additionally, many small retail business owners finance their companies with revenue loans based on future credit card sales (Merchant Cash Advance). Finally, there are others who collateralize loans guaranteed by their personal residence using long-term amortized real estate loans. So, there are many loan or quasi-loan types, but they all have one thing in common. And that thing is, they require repayment of the loan through periodic installments of some kind by the borrower (business or business owner).
Factoring is Never a Loan
Compared to traditional loans such as those mentioned above, factoring stands out for many reasons, but most obviously and most importantly, factoring is never considered a loan. Factoring financing arrangements are always structured as the sale of an asset used to get money. And, of course, that asset is accounts receivable (invoices due and payable). Factoring does not mean injecting “new” capital into a business. Factoring is simply used to speed up the “recovery” of a business’s working capital that gets tied up in the normal sales process when one business grants extended payment terms to another as goods are sold or services performed. Simply put, the accounts receivable of a business represent payments owed to it from other businesses who arranged for 30 – 90 day terms to make payment when they purchased. Factors purchase such accounts receivable so the selling business no longer has to wait 30 – 90 days to get paid. Factoring just speeds up “cash flow,” or the cash that would typically flow from a buyer of goods or services to the seller or provider of goods or services, but would take 30-90 days to do so.
For Rapidly Growing Businesses
Factoring solves a common problem for rapidly growing businesses where sales (granted with terms of payment) overwhelm and deplete the working capital of the company to the extent the seller does not have the cash on hand to pay employees, replace stock, and pay the day-to-day bills and expenses of the business. Such cash-strapped business owners do not need a loan to inject more capital (which would require monthly loan payments). They need to free up the working capital tied up in their accounts receivable and payments already due from customers. And it is the job of factoring, universally recognized as the financial tool of choice, to do just that.
Loan Repayment vs. Factoring Repayment
When a traditional loan of capital is used to finance a business, that loan must be repaid and such repayment usually occurs in some type of installment. For example, a bank that lends a business owner $50,000 expects that business owner to walk through the door each and every month and make a loan payment. In other words, the bank looks to the borrower to repay.
Factoring is different and it’s because, as you now know, factoring is NEVER a loan. When an accounts receivable factoring arrangement is put in place to provide business finance, the factor never looks to the business owner to walk through the door to repay the periodic advances of capital. And that is because the factor’s advances of cash when purchasing invoices are automatically repaid as the purchased invoices are eventually paid by customers. Factors purchase invoices and invoices are, by definition, self-liquidating. Barring the occasional trade dispute where a customer feels an invoice should not be paid due to bad service or a faulty product, the factor is repaid unconditionally within the allotted time frame granted under the terms of payment granted to the selling business and the buying business of goods or services.
Credit Issues and Concerns
Another important concept or feature of factoring vs. commercial lending and one that all brokers and consultants should understand involves “credit” or, more specifically, a financing provider’s determination as to whether the business represents an acceptable financing risk. In a lender’s layman’s terms, “Am I going to get repaid?”
Banks and traditional lenders look to the borrower and the borrower’s (or business’s) credit history to make that determination, and this can also significantly affect the amount of collateral that must be present for a loan to be granted. For example, a business owner with slightly tarnished credit and opening a new business with no credit history will likely have great difficulty obtaining financing. In fact, in such an instance, it would be common for a traditional lender to require personal assets, such as a home, to even consider such a loan.
Factoring, of course, is quite different. When applying for a factoring arrangement, the creditworthiness of the customers of a business (those paying the invoices) will be the primary concern of the factor. The credit history of the business owner or business itself will play a minor role in determining whether a factoring arrangement can be granted and put in place. For industry brokers and consultants, understanding the issue of credit is immensely important since it opens enormous doors when it comes to business development and locating qualified prospects for factoring services.
B2B Current Invoices Only
Another important key characteristic regarding commercial factoring is that its a “business-to-business“ financing method. Except for a very few exceptions, factors only purchase invoices from a business that are due and payable from another business. They do not purchase consumer receivables. For example, if a cleaning service offered both maid services to individual consumers and janitorial services to business owners, only those invoices payable by the business owners would qualify for factoring.
Additionally, factors are not debt collectors and do not purchase invoices that are “in dispute“ in any way. Brokers and consultants, when explaining factoring as a financing option to business owners, will often find that the business owners immediately assume the factor to be a debt collector of some kind. Nothing could be further from the truth. Though you may occasionally find a factoring firm that does have a debt collection division or department, that service is typically not associated with the finance division.
Brokers: Factoring Aids in Your Business Development
For brokers and consultants involved in alternative commercial finance, developing a well-grounded knowledge of the above concepts regarding factoring and having them “at hand“ when discussing business finance with a prospective client will greatly enhance your success (and commission income). For new brokers and consultants, and as you will continue to learn, factoring fills a vast gap in business finance that is difficult for most traditional business finance methods to fill. Add in the near-legendary residual and life-of-account compensation paid by factors for quality client referrals from brokers, and you can immediately understand why developing a solid knowledge of factoring and its ready availability to almost any small business operating on a B2B basis is knowledge all business consultants, independent industry brokers, accounting professionals, and even bank lending officers should strive to establish.
