Factoring is an easy to use method of evening out your cash flow when it’s used in ways that minimize the cost and ensure your payments show up at predictable times, but it’s not for every business. Only companies that work on an invoice system can qualify, since you have to be able to assign payment of those invoices to your factor as part of the process. It works like accounts receivable financing that way. Unlike financing receivables, though, the transaction with a factor is final. The invoices are no longer on your books, and if the customer does not pay, that is the risk the factor takes.
The biggest reason companies are reluctant to use a factor is the perception of a high cost for the service. While the costs can be steep under certain circumstances, they’re a lot like the costs for any other financial product in that they can be reduced and controlled with the right processes. Factors are like lenders, they price their services according to a perceived risk of doing business. If your customers have strong credit and a solid payment history with your business, then your invoices cost less to factor. If you keep on doing business with customers who frequently pay late or not at all, the risk rises and the costs go up if the service is available at all.
Other than maintaining a customer base made up of clients with a strong payment history, there are a few other ways to minimize your costs. For starters, factoring all your invoices at once can help. By providing a large lot of invoices to the factor, you spread the risk of nonpayment out, allowing for a payment that makes up a larger portion of the face value of your receivables. Finally, choosing to factor invoices that are still fresh minimizes the cost. The longer the customer has gone without payment, the higher the risk of nonpayment. If you send out your invoices every four to six weeks, you never wind up with excessively old ones on your books.
Practically any business that operates on an invoice or invoice-plus accounting system could use this service, but many opt for other resources. In general, invoice-based businesses make use of factoring when consistent cash flow is a primary issue and when there are advantages to outsourcing the business’s receivables. It works for manufacturing, B2B services, logistics companies, and even contractors. Medical businesses and construction firms even have their own versions of the product that’s been fine-tuned to each industry’s needs.