Small Business Factoring Explained

Summary: The financial landscape continues to change with tighter credit and lending restrictions spawned by the sub-prime mortgage breakdown. For samll business this is an explanation of factoring for small business owners, and how it relates to the current state of the economy.

How Factoring Fuels Small Business Growth

By way of definition, factoring is a process through which small business owners can convert accounts receivable (invoices) into much-needed working capital. Thus it is also referred to as invoice factoring for small businesses.

Let’s say I operate a small business that uses an invoicing system to bill clients. At any given time, I have a good deal of capital in the form of outstanding invoices. These invoices represent future revenue, but they do not help me much here in the present.

Now let’s imagine that April is going to be a big month for material or supply purchases, but much of my capital is tied up with invoices. This is a scenario where a small business factoring company can help me transform my invoices into working capital; that capital I can put toward those necessary purchases next month.

So as the business owner, I would work with a factoring company to transfer some (or all) of my invoices over to them. The factoring company would advance me a portion of the invoice total – let’s say 85% for this example.

Now I’ve converted 85% of my outstanding invoices into capital I can use to make my supply purchases. My customers who owe the invoices will now send their payments to the factoring company, instead of sending them to me. This is the crux of small business factoring and how it can benefit your growing business.

A Much Needed Tool in Today’s Economy

Our current economic troubles only make this kind of financing all the more important. As regulators increase their scrutiny of lenders, the number of financing options for small businesses declines. Thus, there is more need for alternate financing methods such as invoice factoring and other forms of working capital finance.

Importantly: the security for the cash flow is basically provided by your client and not you.
TIP: therefore, additionally, make sure that you add credit insurance to the factoring package..