Business factoring is one of the oldest forms of financing in the world. It provides vital solutions for small businesses and large, new companies and those that have been established for years. It involves nothing more than selling an asset (an invoice) to a company in exchange for cash that is owed to you.
However, for all that, there are quite a few myths and misperceptions out there about the process, how it works, and who it benefits. If you’re a small business owner struggling to keep cash flowing through your business, it pays to know the truth behind those myths, and how business factoring works to benefit your company. Let’s debunk some of the most common myths.
Business Factoring Is Only for Floundering Companies
There’s a myth out there that says business factoring is really only an option for companies that are struggling to stay afloat, and on the verge of failure. Nothing could be further from the truth. In fact, most companies that take advantage of business factoring services are actually seeing significant growth.
They use factoring companies to ensure that they’re able to take advantage of growth opportunities immediately. There’s also the fact that factoring companies actually prefer to work with stable clients who have customers that pay their bills on time, every time.
A Factoring Business Is Actually a Collection Agency
It’s easy to see how this particular myth got started, as it has roots in reality. No, that doesn’t mean that a factoring business actually is a collections agency, but they do collect on your accounts receivable. To understand this, you’ll need to know a bit more about how factoring works. In this scenario, you’re running a profitable but cash-strapped business. You need capital to grow your business, but your customers are slow to pay.
You sell your invoice to a factoring company, which pays you up to 90% of the invoice value immediately. You take that money and use it to pay your bills, build more infrastructure, expand your business or compensate employees. When the factoring business collects from your customer, it pays you the remaining balance of the invoice, less the factoring fee.
At no point does the factoring business act like a collections agency – they simply collect the money when your customer pays their bill. There is no harassment of your customers to pay their bill.
A Factoring Business Is More Expensive Than a Bank
There’s actually some truth to this one, but it’s not exactly what you think. Yes, the fees for factoring can be more costly than the interest on a conventional loan. However, if you’re unable to qualify for a loan, that really doesn’t make much difference. There’s also the fact that business factoring doesn’t add debt to your company the way taking out a loan does. You don’t owe anyone money. You’re selling an asset and receiving the cash that you were owed by your customer in the first place.
This doesn’t negatively impact your business’ credit, either. In fact, if your factoring partner reports to credit agencies, it can actually help to build up your creditworthiness. There’s also the fact that with business factoring, you’re able to receive your cash within 24 to 48 hours. Try getting that sort of speed from a bank.
There are also additional benefits that help to offset the cost of factoring. For instance, you have a regular influx of cash from the sale of invoices, which allows you to take immediate advantage of opportunities, obtain discounts for early payment of your own bills, meet tax liabilities immediately and more. All of that adds up, and none of it can be found with business loans from the bank.
Only Large Firms Can Use Business Factoring
This is definitely a myth, and it’s difficult to see where it got started. Any business, of any size, can make use of business factoring to ensure they have access to the cash needed. You don’t need to be a Fortune 500 company to work with a factoring business. All you need is an invoice for a creditworthy customer that’s slow to pay.
In fact, factoring is actually a highly beneficial option for small businesses and start-ups. If your business is struggling with cash flow problems but has reliable, reputable customers that do pay (although slowly), you can use factoring to ensure you have liquid capital available when you need it, for whatever you need.
Business Factoring Hurts Your Company’s Reputation
This one is akin to the myth that factoring companies are actually collection agencies. It’s also tied into the myth that only struggling companies on the verge of failure use factoring firms. There is no truth to the myth that working with a factoring company will hurt your business’ reputation.
In reality, working with a factoring company can be highly beneficial, ensuring that you have access to capital at all times, even when your customers are slow to pay their invoices. There is also the fact that most of your customers are already aware of business factoring and its benefits. If they see that the practice ensures you are able to stay afloat, and that their payments are being accurately credited, they are unlikely to have a problem with it.
Of course, you will find that some factors will allow you to be discrete about their involvement, meaning that your customers won’t necessarily know their invoice has been sold.
You Give Up Control
Again, there’s a kernel of truth to this one, but it’s not what you assume. When you sell an invoice to a factoring business, you receive the cash that you’re owed and the factoring company will collect on the invoice. However, you’re not necessarily required to give up all invoices from a particular customer to the factoring firm. Many factors will let you choose which invoices are sold and how the entire process is handled.
With that being said, quite a few factoring companies are happy to provide invoicing and collection services to their clients (you). This frees up your time and allows you to focus on growing your business, which is what you do best. Again, this is often a vital solution for small businesses and start-ups where the owner may have little or no experience with receivables management.
A Factoring Business Can Only Give You Money
Again, this myth is false, as we discussed in the point above. The truth is that most factoring companies are happy to offer additional services, including receivables management, invoicing and collections. However, you don’t necessarily have to take them up on those offers. If all you need is cash flow and want to maintain control over all other areas of your business, you can find a factor that will work with you in that way.
There are plenty of different options available, so you just need to compare factoring companies and find one that fits your particular needs, whether that’s just providing cash in exchange for invoices, or providing a range of supporting solutions and services.
A Factoring Business Won’t Deal with New Companies
We’ve already mentioned that if your company is new, factoring companies will work with you. There is no truth to this myth. In fact, factoring companies can offer vital help to new businesses struggling with slow to pay customers. This myth likely grew out of the way conventional lenders work – if you’re not an established company, most banks won’t give you the time of day. That’s because conventional lenders are looking at your creditworthiness.
With a factoring business, they’re looking at the creditworthiness of your customers, not your company. That changes the conversation entirely. Of course, there is the fact that if your customers aren’t particularly creditworthy, or have a history of not paying their bills, you might have trouble finding a factoring company to work with you.
Working with a Factoring Business Is Just a Temporary Solution
There is some truth to this. Working with a factoring business may not be the right decision for you, for the long term. In that instance, it is a temporary solution. However, it doesn’t have to be. If you find that having the additional assistance and benefits of an experienced team of financial specialists pays for itself, there’s no rule that says you have to stop working with them.
With that being said, many companies do use factoring on a shorter-term basis, usually only for a year or two. This provides them with significant liquidity during the interim, while building history and establishing creditworthiness so they can work with conventional lenders later on down the road. The reality here is that factoring provides cash flow solutions for both the short and long term, and you can work with a factor for as long (or short) as you like.
A Factoring Business Is Difficult to Work With
This myth has some grounding in reality. After all, factoring companies come in all shapes and sizes. There are those that specialise in a particular industry, as well as generalists. That also includes companies that are worth your time, and those that should be avoided. Like any other business out there, you will find that some factoring companies are hard to work with.
The trick is to do your research before working with one. You’ll need to compare your options, read their terms, study the language of any contract, and really dig into how the factoring company works. It’s also highly beneficial to speak with past clients of the company to learn about their experience, about the level of customer service offered, about any hidden fees or charges that the company doesn’t talk about, and more.
While the myths we’ve covered are just that – myths and half-truths – there are quite a few things that you’ll need to know prior to signing a contract with a particular factoring company.
Business factoring can be expensive if you choose the wrong partner and fail to read the fine print listing hidden fees and charges assessed by the company. It can also leave you tied to a company for longer than you wanted, or might result in less discretion than you would prefer regarding the sale of customer invoices to a factor.
There are also many different types of factoring, and one may be a better fit for your particular needs than another. Your industry also plays a role. For example, construction factoring differs greatly from freight invoice factoring, which differs significantly from other industries.
Moving Toward Steady Cash Flow
As you can see, there isn’t much truth behind the myths surrounding business factoring. Of course, that still leaves you with the need to find the right factoring partner for your specific requirements. Again, there are many factoring companies throughout Canada, and they’re far from being identical. It is your responsibility to conduct due diligence before signing a contract with any business factoring company.
It can be difficult to make an informed decision about which factor to choose. You’re a business owner, and your time is precious. Every minute spent comparing factoring companies is a minute that you’re not focusing on growing your own business. We can help. We invite you to take advantage of our free factoring consultation with a factoring specialist. Finding the right partner doesn’t have to be frustrating or time consuming. Find out how simple it can be to ensure stead cash flow for your business.