Factoring Financing Articles

For many years, companies have relied on venture capital financing to grow and expand their businesses. Recently, most venture funds have been reduced in scope and size to deal with the current economic environment. Unfortunately, this has had a substantial effect in the broader economy by limiting entrepreneurship and innovation – key component of economic success.

Without venture capital, many business owners try to finance their companies by looking for a business loan from a lending institution. However, business loans are only given to companies that have strong collateral and can show profitable operations. Companies will also need to provide financial statements that will be rigorously reviewed to ensure that they meet institutional criteria. Because of this, this type of business financing is out of the reach of many business owners, especially at this time.

There is are alternative ways to finance your company. They can help you expand your company organically without generating any new debt. And more importantly, without having to give any equity in the business to someone else. Remember that when you use venture funding, you are selling a piece of your company to someone else. They will want a say on how things are done. Many times this is good, since venture capitalists usually have seasoned executives that can help you. However, it will take some of your independence away.

There are two alternatives that can help you, depending on your situation and line of business. One if factoring financing. Factoring bridges the 30 to 60 day gap between invoicing a commercial customer and actually receiving a payment. This advance payment enhances your cash flow, providing you with funds to pay current expenses and grow the business. The other alternative is to use purchase order financing. PO Financing only helps product resellers who have a large order and don’t have the funds to buy the product from their supplier. In both factoring and purchase order financing, the transaction is settled once the customer pays the invoice. And as opposed to other types of financing, the most important collateral if your customers credit rating. Thus, you can leverage your clients credit rating to fund operation expenses and growth. This makes factoring and purchase order financing an ideal solution for many businesses.

Finding financing has always been relatively easy for established companies, provided that they have a track record of success. Most companies that have sales in the range of a million dollars per month can find financing from either their local bank or from other institutions. It’s a different story if your company is smaller though.

Everyone agrees that having the right capital structure with the right sources of financing is critical for the success of a company. The problem is that few institutions are willing to make a business loan or offer any type of business financing to small companies. Large institutions don’t like to lend to small businesses because they find them risky. In part they are right, small businesses have a high failure rate. On the other hand, a small business has a very low chance of succeeding unless they find appropriate funding.

Most business owners will try conventional sources of financing at first. And some will actually succeed in getting business loans or similar financing from their local institutions. But like all small business owners, they will need to show an established track record of success and will need to have substantial assets to back up the financing request. However, if conventional sources fail, few business owners know where else to go for financing.

One possible alternative is to use invoice factoring. One common challenge for small companies is working with commercial and government clients that pay in 30 to 60 days. This practice of offering terms usually ends up tying the company’s capital, restricting their ability to pay vendors or employees. This also restricts their ability to pursue new clients, since they lack the capital to service those accounts. Factoring invoices eliminates this problem by advancing you funds against your invoices. Instead of waiting for your client to pay – you can have the factoring company advance you the funds (less a discount). These funds can be used to pay existing obligations or be invested in new projects or clients.

A major advantage of a using accounts receivable factoring is that most company owners can obtain it relatively easily. To qualify, companies need to have a solid roster of commercial or government customers. Companies also need to be free of major issues – or if they have problems – they need to have a turnaround plan in place.

The reason accounts receivable factoring is easier to obtain than other sources of financing is that they look at your invoices from customers as their main collateral. This allows companies that have a solid base of clients to use that as leverage to fund operations and growth.

Capital rationing is an all too common problem in the current economic environment. Simply stated capital rationing occurs when you have more profitable projects than funds to implement them. Because of this, firms must ration (or limit) their expenditures and only do the most profitable ones – those that have the best internal rate of return or highest net present value. However, capital rationing may also prevent you from launching profitable projects, limiting the scope of your business.

At a much simpler level, it means that you are not making as many sales as you could. Let’s say that you have $50,000 and have two sales opportunities. Each sale opportunity requires a $50,000 investment to buy supplies and deliver the service. Sale opportunity #1 has a return of 15%. Sale opportunity #2 has a return of 20%. Logically, you choose sale #2. But what if sale #1 is still profitable for you? Wouldn’t it be great if you could also pursue that project? Well, you can’t because you lack funds. You have to ration your capital and can only pursue one opportunity. This can be painful for business owners that are forced to turn sales away.

One obvious solution to the capital rationing problem is to get business financing. That is easier said than done, especially in the current economic environment. Both business loans and lines of credit can be used to deal with capital rationing but can be difficult to obtain, especially for small and midsized companies. Qualifying for a business loan usually complicated and requires that a company be profitable for a number of years. Usually, most banks and institutions will also require substantial collateral before providing a business loan.

One alternative is to use factoring financing. Most companies have to wait 30 to 60 days before their invoices are paid by commercial clients. This has a negative effect on cash flow and many times affects a company’s ability to take on new projects. Invoice factoring provides an advance on your slow paying invoices, eliminating the payment wait. This accelerated payment enhances cash flow, providing funds that can be deployed to start new projects.

Whether factoring can help with your capital rationing problem is a complex question that varies based on each opportunity. However for many companies, especially those that are payroll intensive (e.g. staffing companies), factoring financing can provide to be the right solution to finance growth.

Getting any type of business financing has been incredibly challenging for business owners. One of the market segments that has been most affected by this are middle sized companies. Although bigger than their small company counterparts, they are usually not big enough to qualify for the business financing options that are available to larger companies. But without financing, most will never grow or flourish.

One alternative is to go the conventional route and try to get a business loan (or a line of credit) from a bank or a lending institution. However, credit requirements have been tighten substantially and few businesses are able to qualify for any type of financing. And those that do must be ready to provide and substantiate a long standing track record of profitability. Additionally, both companies and business owners can expect to put more collateral than previously required to secure the loan. Although conventional business financing may be out of reach for some companies for the time being, there are other options that can be used to finance their growth.

One alternative is to use invoice factoring. This type of financing is ideal for companies that have clients that pay in 30 to 60 days, but needs the funds sooner. Factoring helps businesses that need to convert invoices into cash to meet payroll or start new projects. One advantage of factoring over other alternatives is that factoring companies are most interested in the strength of your invoices, as that represents a company’s best collateral. So a midsize company that has no other collateral than invoices from strong clients can usually qualify. Companies that usually benefit from this type of financing are labor intensive businesses, such as staffing agencies, and consulting companies among others.

But factoring can’t always help every company. Consider this example. Suppose a product reseller, gets a large order from a retailer. The reseller needs funds to buy the product from their supplier (or manufacturer), in order to fulfill the purchase order. One good alternative is to use purchase order financing. Purchase order funding can provide the funds to pay the supplier, enabling them to fulfill the order. The transaction is settled once the retailer pays for the goods. Qualifying for purchase order funding is harder than qualifying for invoice factoring. To qualify, the transaction must have a minimum of 20% gross margins and the client must buy the finished goods from their supplier.

Although not widely used yet, these business financing alternatives have been gaining traction in the current economy. They enable mid size businesses to grow by allowing them to leverage on their most important assets – the purchase orders and invoices from their customer base.