What Is Factoring?

When exploring ways to fund your business’s operations, you may come across factoring. It’s become an increasingly popular funding solution because of its ability to provide businesses with immediate capital, which they aren’t required to pay back. To determine if it’s right for your business, though, you must first understand how invoice factoring works.

What Is Factoring?

Overview of Factoring

Invoice factoring is a business funding method that involves the sale of a business’s accounts receivable to a factoring company at a discounted price. When customers owe your business money for products delivered or services completed, you can attempt to collect that money, or you can sell the invoices to a factoring company.

Advantages of Factoring

You aren’t required to repay the money generated through factoring. If you take out a business loan from a bank — or even an alternative lender for that matter — you’ll have to repay it, typically with interest. Factoring isn’t a loan, though. It’s essentially a transaction in which you sell some or all of your business’s accounts receivables to a factoring company.

Even if you have bad credit or no credit, you can still fund your business’s operations through factoring. Factoring companies pay little or no attention to credit and profits. Rather, they only care about the value of your business’s accounts receivables. If your business has a substantial amount of unpaid invoices (accounts receivables), you can generally sell them to a factoring company.

Disadvantages of Factoring

On the other hand, factoring companies typically won’t purchase your business’s accounts receivables at face value. If your accounts receives add up to $100,000, for example, a factoring company may purchase them for $90,000.

Factoring also requires the use of accounts receivables — and not businesses have accounts receivables. If your business requires customers to pay in advance, you probably won’t have any accounts receivables, in which case you won’t be able to use factoring.

Is Factoring the Same as Accounts Receivables Financing?

Although they are similar, factoring is not the same as accounts receivables financing. Factoring specifically involves selling accounts receivables to a factoring company, whereas accounts receivables financing is a secured loan requiring the use of accounts receivables as collateral. Both types offer an attractive alternative to traditional business loans, but you’ll still have to pay back an accounts receivables financing loan.

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