Question: My small business is growing, and I may be seeing a dramatic rise in orders soon, which is great. However, I don’t have the cash available to purchase the materials for large orders. Is “factoring” something I should consider?
Factoring is a special type of financing that can be a good option for the right business in the right circumstances. So, what is that business and what are the circumstances?
First of all, I should give a brief explanation of factoring for those that may not be familiar. Having a master’s degree in French, I decided it would be best that I go to Wikipedia as opposed to relying on my interpretation of this financial tool. “Factoring is a financial transaction whereby a business job sells its accounts receivable (i.e. invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially a financial asset), not the firm’s credit worthiness. Secondly, factoring is not a loan — it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.”
Yup, much better explanation than I could have done.
I also reached out to Darlene Friedman, a certified public accountant and owner of The Interface Financial Group, which specializes in factoring (commonly referred to as invoice discounting but not exactly the same thing). Friedman typically works with companies that are growing but don’t meet the requirements for a traditional bank loan or line of credit. The rates vary depending on when the account debtor pays IFG. The invoices her company would buy are strictly commercial, and she recommends that a company looking to sell invoices to generate cash has around a 30 percent margin in order to still retain some profit after paying the fee associated with the factoring service.
Friedman’s clients often sell her their invoices when they need cash for supplies or overhead such as payroll. She doesn’t recommend this type of business financing for someone looking to buy equipment or real estate. A company that is struggling and simply looking for an infusion of cash to keep their doors open is also not a good candidate for this service.
Funding your business at its various stages can be challenging and even a bit scary. Whether you have tapped into your savings, credit cards, family, investors, bank or other business financing institution, you have taken a risk. Taking risks (and by that I mean educated, well-thought out risks) is all part of being an entrepreneur. It may mean you work a heck of a lot more than you thought you would, make less money in the short term and perhaps even lose a few dollars and a few hours of sleep along the way, but it really can be the best decision you ever made.
Whether you have been in business for 20 years or just getting started, we have the resources and the expertise to answer your questions. You can e-mail me at Christine.Davis@dred.state.nh.us. I look forward to hearing from you.