Cash flow is the lifeblood of any business, but can be especially crucial to small and growing businesses. The natural lag between purchasing supplies and collecting sales receipts from customers can slow the flow of that lifeblood, placing limits on growth and possibly threatening the viability of the company. To shorten the time between cash investment and collecting a return on investment, many businesses use the services of a factoring company.

Factoring companies buy receivables at a discount, in exchange for providing cash up front representing some portion of the value of those receivables. This practice can be a useful cash-flow management tool under any circumstances, but can be especially valuable during economic slowdowns. During slowdowns, cash flow issues can become acute, as customers delay payments and banks tighten lending standards. A factoring company can solve this problem by keeping cash flowing healthily.

How Does Factoring Work?

It helps to start by remembering that in accounting terms, receivables are an asset. Normally, the big drawback of these assets is that they are illiquid until payment is collected on them. A factoring company, however, can provide some liquidity for these assets up front.

The merchant that owns the receivables and the factoring company start by agreeing on two things: the amount of cash advance to be provided up front against the book of receivables, and the fee to be earned by the factoring company in return for buying them.

Compare factoring rates before selecting the right factoring services company to accelerate your cash flows. Fees for factoring services are typically between 1 and 5 percent. The shakier the credit of the merchant's customer base, the higher the fee is likely to be. Suppose the factoring company and the merchant agree to a 3 percent fee on $10,000 worth of receivables. Effectively, this means the factoring company has agreed to purchase those receivables for $9,700. The factoring company then provides the bulk of this to the merchant upfront, holding back a portion as a reserve against collection problems. The factoring company will then handle collections, and assuming the receivables are eventually paid in full, forward the remainder of the reserve to the merchant.

Benefits of Using Factoring Services

In exchange for selling receivables at a discount, the merchant can realize several benefits:

• Cash flow is accelerated, meaning money is available sooner to pay off existing obligations and reinvest in the business
• The merchant can spend more time on the core business, and less time managing receivables
• New businesses without a credit history can obtain start-up financing that wouldn't be available from banks
• Approval is expedited, with a much more streamlined process than for a loan
• Approval is based on the credit quality of the merchant's customers, not on the merchant's credit history, so a business with credit problems but a good customer base can get access to financing.

Key Issues in Choosing a Factoring Company

What are the key issues involved in choosing a factoring company? Here are some points to consider in the decision process:

• What fee will the factoring company charge? This fee is highly dependent on the characteristics of the receivables involved, so getting competitive quotes can be well worthwhile.
• What is the processing time, from application to payment? Since factoring is largely about solving a timing problem with cash flows, response times are very important.
• How well funded is the factoring company? Ideally, a successful factoring relationship should become a regular part of doing business, so the ability of the company to provide financing on a consistent basis matters greatly.
• What track record does the factoring company have with similar businesses? A proven fit means the factoring company should not just understand the merchant, but also the merchant's customer base.

Factoring is applied to a wide range of businesses, including both products and services. It is applicable to so many situations because whatever the nature of the business, cash flow is pretty much a universal challenge.