The facts behind factoring

There is nothing more frustrating to a business owner then having to turn away sales because he or she lacks the cash flow to support them. For companies that sell products, this means not being able to replenish inventory in time to capitalize on new opportunities. For companies in the service industry, this means not being able to pay the additional employees (or hours) needed to cover additional service requests. This problem is fairly common, especially for small and mid-size businesses.

If you are not able to get approved for bank financing, there is an alternative solution that can work better than a small business loan — especially if your challenge is that you cannot wait 30 to 60 days to get paid by clients. It's called “factoring.”

Factoring is a financing method in which a business owner sells accounts receivables at a discount to a third party (factor) for immediate cash. For example, you have an invoice for $1,000, which your customer is not going to pay for 30 days. This creates a cash-flow issue since you might need the money to meet payroll or buy inventory. You can submit the invoice to the factor and they will usually advance 75-85% of the invoice amount to you within 24-48 hours once they have verified your invoice. The factor will hold the remaining 15-25% in reserves. Once your customer pays the invoice, your fee is calculated and deducted from the reserves with the difference being refunded to you at that time.