Factoring, as an alternative to traditional financing, is increasing in popularity for businesses in Canada and the US. It's the nature of the factoring model itself that's attracting business owners who are looking to free up cash flow for their businesses.
How is accounts receivable factoring different from applying for a bank loan?
In addition to being faster and having considerably less red tape, factoring has three main differences from obtaining financing through a bank loan.
Qualifying for factoring is based on your customer's credit score
One of the main differences between factoring and applying for a business loan is how the financial institution determines your creditworthiness.
- When you apply for a business loan, your bank will base their decision on how creditworthy you and your business are.
- When qualifying for factoring, the decision is based on how creditworthy the customer you've just invoiced for services is.
That's why factoring is especially helpful for a business that's already stretched its available credit, or to a newer business that has yet to build its credit history.
Factoring takes a different approach to what's considered acceptable collateral
- For a business loan, you'll often be asked by the bank to put up collateral such as a building or piece of equipment.
- With invoice factoring, the invoice sent to your client (ie: your accounts receivable) becomes your collateral.
Factoring doesn't require you to make loan payments
- Most business loans require regularly scheduled payments stretched over a specified period of time (for example: monthly).
- With factoring, you receive up to 90% of the invoice amount within 24 hours of submitting your invoice to the factoring company. The factoring company then waits for your customer to pay that invoice (usually between 30 and 90 days). You make no payments, because your customer pays the factoring company directly.
Why do business owners choose factoring as an alternative to traditional financing?
Some Canadian and US businesses may not qualify for traditional financing such as:
- a business with an over-leveraged balance sheet or recent operating losses
- a start-up company with no financial base
- a high growth business that's growing faster than its cash flow
- a business in transition
Busting the myths about factoring
Simply because a business uses factoring as a financing solution, it doesn't mean that the business is experiencing financial problems. Often, a business will be doing well financially but will be operating in a business sector that the banks consider high risk. For example, when the automotive industry took a plunge a few years back, a number of companies who serviced that industry suddenly found it difficult to get financing...even though they were showing healthy profits and balance sheets. They turned to factoring to keep their cash flow flexible...and their businesses growing!