It’s sort of a Catch-22 situation: a new B2B seller is doing so well, it doesn’t have needed cash flow because of invoicing that allows buyers to pay off their debts in 30 to 60 days. Factoring, however, is playing a role in helping such companies make it through their early growing pains, complementing such other options as business loans and early-payment discounts.
As PYMNTS.com noted earlier this summer, larger vendors are extending how long buyers have to pay so customers can float their expenses over a longer time period, often for as long as 120 days. Smaller firms, however, don’t have the luxury to support such interruptions in cash flow, so they need to get their money quicker.
And while startup alternative-financing companies such as PayPlant are addressing such challenges by providing small and midsize businesses a digital invoicing service that reduces the interest on advanced funds while awaiting payment for their services, other forms of factoring also can help by financing slow-paying invoices.
How factoring works
In a recent blog post on Factor This, entrepreneur and financial specialist Marco Terry, who owns a factoring company, argued how factoring can help companies by providing them an advance, often a percentage of the gross value of their invoices. Companies often factor invoices on a recurring basis until they have built sufficient reserves.
“This gives your startup funds to operate,” he said. “The transaction concludes once your end customer pays the invoice in full.”
Factoring companies often buy invoices in two installments, called the advance and the rebate, Terry noted. The first installment, the advance, covers about 85 percent of the invoice and is advanced as soon as the seller sends an invoice to their client. The remaining 15 percent, less a fee, is rebated as a second installment, as soon as the client pays the invoice in full, he said.
Through factoring, companies have an easier time securing funds than through a business loan. The underwriting criteria is simpler, which makes it a viable option for startups that don’t have a long track record or substantial assets, Terry said.
Moreover, the lines of credit can be written relatively quickly, as long as the business has not issues that could affect the financing. Issues that can delay funding include past bankruptcies, unpaid judgments, and liens encumbering accounts receivable, Terry noted.
Another benefit of factoring is that it can help buyers evaluate the creditworthiness of potential clients before signing them on, thus decreasing their bad debt. “This allows you to be more selective about who you offer credit terms to,” he said. “Obviously, clients with good credit can get net 30 to net 60 day terms.
Indeed, factoring only works when clients have good credit a factor purchases a seller’s invoices and provides them with an immediate advance for them, Terry noted. The factor will not look at the assets of the company too closely, he said. “Instead, they will look at the credit quality of your invoices,” he said. “They will only buy invoices that are payable from companies with high credit ratings."
Factoring is not the primary option companies should consider to improve cash flow, however. Instead, they first should consider providing slow-paying customers with early-payment discounts, Terry advises.
"This is usually cheaper than factoring invoices and can work well,” he said. “Most companies offer a 2 percent discount if the client pays within 10 days. Clients like this because the discount increases their profitability. Obviously, startups like it because it improves their cash flow."