The Role of Factoring Companies in Small Business Financing

For a small business entity, getting that all awaited break with a ‘big deal’ would mean everything. However, the breakthrough deal may be worth substantial money and requires the small business to raise substantial amount of funds to go ahead with the deal as they want get paid up front. With a low level of assets and marginal borrowing capacity, for a small business, the ‘big deal’ may not be a reality after all. But, ‘factoring’ may provide the small business with the answer they need and could well fund the transaction up front.

In order to understand how factoring companies function, let’s take an example. Imagine a small company issuing goods worth 5000 USD to one of its clients. Obviously, the client may not release money until the goods have been sold or will require few months before it makes the settlement. Thus, the company issuing the goods has to wait for few months before it gets paid in full. It means that, the company cannot invest the money receivable in relation to its invoices for a considerable period of time. For a small business with a minimum capital, this can be disastrous if it miss out on any further dealings coming their way within that period. This is the time where factoring companies can intervene.

In a scenario such as the one described above, the small business can sign a deal with a factoring company to buy the invoices for a small fee. For instance, the factoring company may pay the above business 4,750 USD and will collect the total worth of the invoice from the client directly. Thus, the burden of collecting debt will also be off from the shoulders of the small company and they can focus on re-investment than waiting for their clients to pay.

In another scenario, a company which could not collect a debt of 20,000 USD from one of its clients could seek the help of a factoring company to purchase the invoice for a reasonable price; in this case the gain for the company could be relatively low due to the low confidence level on the client. However, the company could continue with their business rather than focusing their attention on recovering bad debt.

In a third scenario, a small company which does not receive a smooth cash flow at the end of the month may have trouble planning out its activities or borrow money from other financial institutions. In such instances, they can seek the partnership of a factoring company which will guarantee the company with a smooth cash flow at the end of each month depending on the amount of invoices issued while they will deal with the clients of the company in order to collect the cash.

Similarly, there are different scenarios in which factoring companies can assist small businesses financially. However, the intervention of factoring companies needs to be done smoothly as it will put the clients off and may not reflect well on the company itself. Thus, all customers and clients must be informed of the interventions made by the factoring companies on behalf of the business and should assure the clients that they will extend the same courtesy and goodwill extended by the business towards its clients.