Many business people who have never used accounts receivable factoring have certain misunderstandings about it. These encompass everything from the details of a transaction, to the type of businesses that use factoring to create working capital for their company. The following are a few of the most common misconceptions, and some information to help us understand the facts better so that you can make smart decisions for your business based on the reality.
No. Even though it is a financing strategy is does not work exactly like a loan. You can use the funds as you would the cash from a credit loan, or bank loan, but factoring is not considered a loan, but a sales transaction. It does not show up on your balance sheet as debt. Therefore it does not create a liability on your balance sheet or affect your debt to equity ratio except to lower it if you use the funds to pay off any debts with the proceeds. The factor actually purchases your invoices and advances you 70 to 90 percent upfront, and the remainder after the invoice payments are collected, minus the factoring fee. The fee typically ranges from 1 to 3 percent.
This depends on your situation. If you use the funds to grow your business through marketing or to eliminate payroll expenses for accounts receivables, factoring can actually save you money. Factors generally take on many of your accounts receivable tasks. For example, they examine the credit of your customers, collect the payments on the invoices, and provide you financial reports that detail the status of your receivables. While the rates may be higher than some low-interest business‚Äôs loans, that‚Äôs irrelevant if you can't qualify for the loan. So you really have to think about the cost of not having the cash you need to grow your business by funding acquisitions, implementing marketing and promotions, or purchasing more inventory or supplies. In addition, credit lines are limited while the funds you receive from factoring can increase right along with your sales volume.
While it is true that businesses experiencing a tough season can benefit from factoring, many businesses turn to factoring for the exact opposite reason. Factoring is a popular financing strategy for businesses that are growing rapidly. Sometimes these are newer companies that lack an established credit history or that have financial ratios that do not allow them to qualify for traditional bank loans. By using factoring funds to grow their sales volume, they also increase their total profits. Also by decreasing the time interval for outstanding invoices, some are able to capitalize on early payment discount from suppliers.
Although many companies and industries use factoring as an ongoing financing strategy, a long-term commitment is not required. Some companies use it as a short-term strategy to improve their financial standing for a traditional bank loan, navigate seasonal supply and demand issues, jump start growth, acquire other businesses assets, or expand operations.
Hopefully this article has cleared up some of your misconceptions about factoring. If you have any more questions, contact us!
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