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How Can Small Business Factoring Preserve Your Working Capital?

Dane Panes | August 19, 2022

Contents

    Working capital presents the relationship between the business's current liabilities and current assets. It is an indicator of the company’s ability to settle short-term liabilities. Short-term refers to a period of at least six months to at most one year. This means that the business will face immediate trouble if its working capital ratio becomes negative.

    Entrepreneurs must take time to understand their cash flow and create a plan to address any potential problems. Fortunately, there are many solutions for negative cash flow, including small business factoring.

    How Does Small Business Factoring Work?

    Small business factoring involves refinancing invoices that have not yet matured. The first thing you need to do is provide the factoring company with the invoices they want to factor. The lending company will then initiate a valuation process to decide how much they are willing to let the business borrow. This step also identifies the factoring rate or the percentage of the total amount that you will pay the factoring company back.

    Most factoring companies will decide on an 80% borrowing rate. This means that the borrower will receive $80,000 out of $100,000 in total receivables. After providing the cash up front, the factoring company will collect the remaining 20% upon maturity date and forward the balance minus the factoring rate agreed upon earlier.

    If the factoring company decides on a factoring rate of 1% per month and the invoices mature in 30 days, it will remit $19,800 after collection. The provider keeps $200, or 1% of $20,000, as payment for its service to the business. The factoring rate increases the longer it takes for the customer to pay or the invoice to mature.

    How Does Small Business Factoring Preserve Working Capital?

    Small business factoring can help preserve working capital by unlocking cash tied to your pending invoices.

    It also provides you with a source of ready cash to address short-term working capital woes. The service helps the business keep up with short-term obligations without pulling out cash reserves and breaking the bank.

    Invoice factoring is not considered a loan. Although it functions similarly to a cash advance, the business does not repay the factoring company anything. Instead, it pays the provider only when they collect the remaining balance from your customers.

    Invoice factoring also indirectly helps the business retain good business credit. Creditors are happy whenever their clients pay back their debts on time. In return, they will make a favorable report on the your credit history. Having a good credit score happens to be a crucial factor in being eligible for other forms of financing.

    How Does Small Business Factoring Preserve Working Capital?

    Small business factoring can help preserve working capital by unlocking cash tied to your pending invoices.

    It also provides you with a source of ready cash to address short-term working capital woes. The service helps the business keep up with short-term obligations without pulling out cash reserves and breaking the bank.

    Invoice factoring is not considered a loan. Although it functions similarly to a cash advance, the business does not repay the factoring company anything. Instead, it pays the provider only when they collect the remaining balance from your customers.

    Invoice factoring also indirectly helps the business retain good business credit. Creditors are happy whenever their clients pay back their debts on time. In return, they will make a favorable report on the your credit history. Having a good credit score happens to be a crucial factor in being eligible for other forms of financing.

    Benefits of Factoring Over Other Forms of Financing

    Invoice factoring bears numerous advantages over other financing options for businesses. These benefits include:

    • Affordability

    As mentioned earlier, invoice factoring is neither a cash advance nor a loan. Businesses don’t have to repay the factoring anything outside of the factoring rate. In exchange, the enterprise receives up to 95% of the total amount in the invoices. 

    • Eliminates collection processes

    Invoice collection is a time-consuming and labor-extensive task. You may end up paying more for wages than what you collects from your customers. Invoice factoring eliminates that cost by taking over the collection process

    • Instant access to working capital

    The process of applying for invoice financing is straightforward. The factor receives the invoices, assesses their collectability, and decides on the amount the business can advance. You can receive the money within 24 to 48 hours after approval. 

    • No credit check

    The factoring company will not investigate your credit record because they will not be borrowing money. However, the factor will use their backend to check every customer that owes an invoice to assess their capability to settle the obligation. 

    • No spending restrictions

    Most financing options available for businesses have spending restrictions. Equipment financing, for example, should only be spent on acquiring new or leased equipment. The funds from invoice factoring carry no limitations. You are free to use the money within the business as you see fit.

    • A competitive market

    There is a competitive market of invoice factoring providers. You can choose which deal is most beneficial for your goals and needs. They need to take the time to populate their options before making a final decision.

    These advantages make invoice factoring the ideal source of financial assistance for any business. Businesses that deal with terms should make invoice financing the first option they seek if they face working capital problems.

    How to Save Time in Invoice Factoring Applications

    Entrepreneurs can further maximize the benefits of invoice factoring through adequate preparation. Here are some tips that can simplify and speed up the application process when factoring invoices:

    • Pre-qualify invoices

    As mentioned above, invoice factoring companies may take time to check each customer’s credit record. To expedite the process, it's best to go through your invoices and identify which customers have a good payment record. Although the factor will still conduct the check, it cuts down the back and forth between you and the factoring company.

    • Set documents in order

    Factor companies will require additional documentation aside from the invoices. They generally require proof of the applicants’ registration and incorporation and customer records. They may also ask for proof of finances and monthly sales figures. Keep in mind that each factoring company may have its specific requirements aside from the above, so be sure to ask before applying.

    Entrepreneurs need access to funds that they can receive as quickly as possible. These tips above can certainly help in cutting time on the approval process.

    Conclusion

    Companies suffer severe repercussions if they cannot bring their working capital back to order. Fortunately, financing options provide vital assistance in these situations. Invoice factoring is more advantageous for any business than the other choices because of the reasons below.

    First, it does not require the borrower to have an outstanding credit record. Any entrepreneur can apply and be approved provided they have the documentary requirements. The factor may check the credit scores of their customers, however. This step is vital in identifying which invoices they think they can collect when the maturity date arrives.

    The process is also straightforward. You can receive the funds within 24 to 48 hours upon approval and you can use them for almost any business purpose.

    Last but not the least, factoring is not a loan. Small businesses only have to repay the factoring company a factoring fee. This fee is between 3 to 5% and applies only to the remaining balance after the initial cash disbursement. 

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    About the Author

    Dane Panes started freelance writing in 2017. Since then, she has written about a lot of topics for different businesses. She started writing for SMB Compass in March 2020 and has been a full-time content writer ever since. Now, she focuses mostly on topics related to entrepreneurship and business financing.