Invoice factoring can improve a company's market share, profitability, and growth rate by turning an unproductive asset (accounts receivable) into cash.  The infusion of cash flow that factoring provides can be just what is needed to get a firm on track to acquire new contracts, make timely payments to vendors, or even cover payroll.  But the company owner should understand how factoring works and know what is needed to facilitate the onset of the relationship.  Answering the following questions should provide a guide for the company that is considering utilizing factoring.

Is the company a good fit for factoring?

Accounts receivable factoirng is based on amounts owed by other business on credit.  In other words, factoring companies will not be able to advance funds for amounts due from individuals.  In addition, the business customers must have a good credit history.  Since the factor is advancing cash to the client and the only collateral they have is the company's receivables, they must perform due diligence by checking the credit history of each customer.   If several of the customers have poor credit ratings and are slow payers, the factoring company may be hesitant to take on this client.  They may perceive the risk as being too great.

It is also important for the business to achieve a reasonable profit margin in order to cover the factoring fees.  Despite the many advantages that invoice factoring offers, the fees can range anywhere from 2.5% to 4% per month for invoice amounts submitted.  Therefore, the business should enjoy a profit margin of at least 10% to be able to justify the fees incurred.

Are there any liens on the receivables?

Many business owners don't know the answer to this question and it should be determined immediately in order to save time during the application process.  Factoring companies must have a clear title to the receivables in order to offer themselves protection in the event of bankruptcy or other situation in which they are not receiving payments.  To do so, they make what is called a UCC filing which gives them the ability to receive a first position on the receivables.  If there is a lien, factoring companies often work with the lienholder to get it released.  For example, if the company has a term loan with a bank which required all assets of the company to be pledged as collateral, the factoring company could make payments from the initial fundings to pay down the loan and get the lien released.  The same is true if the company has fallen behind on their 941 tax payments and the IRS has filed a lien.  

Which factoring company is the best fit for my business?

Type "factoring companies" into the Google search box and you will see plenty of choices avaiable.  Which one should you pick?  It depends on so many factors.  Some are adept at factoring freight bill invoices while others focus on staffing companies.  Some of the bigger ones may work with all types of business, but exclude the medical and construction industries.  Factoring companies also vary in the amount of minimum or maximum monthly volume that is requred, while others allow "spot" factoring.  Spot factoring allows companies to submit invoices only when needed.  The contracts vary as well.   Some factors may offer what appears to be a good rate, but severely penalize the client when they try to end the relationship.  It can be very confusing.

Utilizing a well-educated factoring broker is an excellent way to find the right fit for the company's situation.  A factoring broker knows the factors that are reputable and will service the account in a professional manner.  They will also serve as an advocate for the client by helping address issues and expediting the application process.  Brokers are an integral part of the factoring process and the best thing is the company does not have to pay them because they receive their compensation from the factoring company.