Small business factoring is a financial strategy that allows smaller companies to make use of their accounts receivable now rather than waiting for customers to remit payments for those currently outstanding invoices. The process essentially involves selling the receivables for a specific billing period to a lender known as a factoring company, which pays a high percentage of the face value of those invoices to the debtor, with more to follow as the debtor’s customers actually do send in payments. While this type of third party financing can be very advantageous, it is important to consider the business model of the lender, their collection processes, and the amount of factoring fees they keep in return for their services.
There are a number of small business factoring services in operation today. While all offer the same basic solution to temporary cash flow problems, not all of them operate in exactly the same way. For this reason, it is important to get an idea of how a prospective partner works with its clients before making any type of commitment. Take the time to find out if the lender sets up a branded lockbox for the receipt of payments, or if your customers must remit payments addressed to the lender. Determine how long it takes for the lender to evaluate and approve the submitted accounts receivable and what percentage of the value of those receivables is tendered up front. It is also important to identify how long it takes for the payment to be received once approval for a given billing period is obtained.
Along with understanding how and when funds are provided for the small business funding, it is also crucial to get an idea of how much interaction the small business factoring will have with your clientele. Some will work closely with your accounting team to collect past due invoices, while others will not involve your business in the process at all. When that is the case, ask to see templates of collection letters that are sent out for invoices, that are 30, 60, and 90 days past due. Also ask to see the scripts that collections agents use when contacting your clients. Depending on the approach that the factoring company takes to the collection process, your relationship with your clients could either be strengthened or irreparably broken, something that is not in the best interests of your business in the long run.
It is also important to consider the fees that the small business factoring partner will ultimately keep for rendering their services. Typically, this is small percentage of the face value of the invoices that were approved as part of the loan arrangement. Depending on where the lender is based, that amount may be anywhere between three and ten percent of that face value. Keep in mind that small business factoring services that tend to offer a wider range of services and work with you in collecting past due invoices will probably charge a little more than those who provide basic services and handle collections without your input. Since protecting your good name with your clients is important to the future of your business, going with the small business factoring company that is a little more flexible and will work with you to resolve issues is a better option over the long-term.