Small Business Debt Factoring- Finance Strategy

Small Business Debt Factoring

Guest Author: Christina, Magnolia Finance.

This is a form of financial strategy that will allow small businesses to make use of their account receivables, which are the accounts that show what a customer owes the business for their products or services.

The small business can use these accounts instead of waiting for the customer to send payments for the products or services they received.  When using the accounts receivables of the business they will sell them for a certain billing period to a lender, which is referred to as a factoring company. 

The factoring company will pay a high percentage of the invoice’s face value to the debtor.  When the customers begins paying the invoices the factoring company will be able to pay more to the debtor for the invoices, or accounts receivable.  This is considered third party financing.

Before using a factoring company, the small business should understand how the company works with their clients before committing to the factoring company for debt factoring.  Some of the things a small business should consider include:

  • Does the lender or factoring company, set up a branded lockbox for receiving payments or if the customers just send their payments addressed to the lender.
  • Finding out how long it will take the debt factoring company to evaluate and approved the account receivables that the business has supplied
  • Finding out what percent of the face value of the account receivables are paid up front
  • How long it will take for the payment to be received by the business once the debt factoring company has approved the accounts receivable for a certain billing period
  • Finding out if the factoring company will work closely with the business accounting team when collecting past due invoices or will they work with them at all.
  • Ask to see templates of the collection letters that the factoring company will be sending to the customers on the invoices that are thirty to ninety days past due along with how the factoring company will talk to the customers when trying to collect payments over the phone. The business wants to be able to have the past due invoices paid but they do not want to lose customers in the process.
  • Look at the fees that the debt factoring company will keep for offering their services to your small business. The percentage that is being taken should be written in as part of the loan agreement.  The percentage can be from three to ten percent of the invoice’s face value.  If the company offers a wide range of services and works with the business to collect past due invoices the percentage could be a little higher.

Advantages of debt factoring

  • When using debt factoring the business can get a fast infusion of cash, generally within twenty-four to forty-eight hours after the business has submitted the accounts receivable to the factoring company. This fast turn-around is great when your business is need of money to buy supplies, make payroll, etc.
  • The cash flow of the business can be improved because with debt factoring or maybe even through invoice discounting Australia your business can continue to grow if the business is not struggling each month to make payroll, pay bills, and get new supplies.
  • Debt factoring can also shorten the cash cycle, which means that the time the business purchases the goods and then selling them and receiving payment for them can be significant. Using debt factoring can make it possible to buy more supplies to sell for more profit.

Disadvantages of debt factoring

  • The one big disadvantage is that the interest rate will be higher than getting business loans from the bank.
  • There is also the risk of harming the relationship with your current customers. These customers may have always paid on time and are just struggling to make a payment at the time so the customer could become angry that a collection agency is sending them a collection notice and demanding payment.  This could make the customer mad and once they pay their debt they look for another business to get their products or services from.
  • If the business has a slow paying customer rate it can mean higher fees paid to the debt factoring company.

This article is penned by Christina for Magnolia Finance. Magnolia Finance is not a bank. Nor does it rely on the services of banks to provide business loans to partners like you. This company offers short term loans for new businesses at the lowest interest rates in the industry.