There is a certain reaction to invoice factoring that I still hear from time to time, especially from business owners who have been around for a while.
This reaction typically happens after I’ve introduced invoice factoring to a company seeking financing solutions. It is usually some version of, “Isn’t that for companies that are struggling?” That assumption is part of why invoice factoring for growth still gets overlooked, even by healthy companies with strong revenue and good customers.
I understand where the perception comes from. Factoring has been used by businesses dealing with financial pressure, and there are companies that turn to alternative financing after other options have become difficult to obtain. Pretending otherwise would not make the argument for factoring any stronger.
What I disagree with is the jump from some struggling companies use factoring to a company must be struggling because it factors its invoices.
Those are two very different statements.
A profitable company can have plenty of revenue, good customers and a healthy pipeline while still having a large amount of its cash sitting in accounts receivable. When that happens, invoice factoring can be used for something very different from survival.
It can be used to grow.
Profit and Available Cash Are Not the Same Thing
A lot of the stigma around factoring starts with a pretty understandable assumption: if a company is doing well, why would it need somebody else to fund its invoices?
Because earning money and having that money available today are not the same thing.
A B2B company can complete $500,000 worth of work this month and send out $500,000 in invoices. On paper, that may be a great month. If those customers pay on net-30, net-45 or net-60+ terms though, the business cannot use most of that cash yet. And its own expenses are generally not operating on the same schedule.
Employees need to be paid and vendors have terms of their own. Insurance premiums, rent, software, taxes and ordinary operating expenses continue while the invoices work their way through the customers’ payment cycles.
This is not a sign that the company is unprofitable. There is simply a timing difference between when revenue is earned and when the cash arrives.
That is not an unusual concept in commercial finance. The FDIC’s Risk Management Manual of Examination Policies specifically identifies rapidly growing businesses among the typical users of accounts receivable financing.
That does not sound much like financing reserved exclusively for distressed businesses.
Sometimes Growth Creates the Need for More Capital
The counterintuitive part is that a company’s cash needs can increase while the business itself is getting stronger.
The same is true across multiple industries. For example, a staffing company could win a large account and suddenly need to put 80 new people on payroll. Or, a security firm might secure a major contract while managing a backlog of other jobs. Prepared or not, these wins put immediate pressure on a company’s cash flow.
Those are good developments. But they can also require cash before the additional revenue has had time to turn into cash in the bank.
This is where looking only at the company’s current bank balance can give an incomplete picture. The business might have hundreds of thousands of dollars, or millions, sitting in legitimate invoices owed by creditworthy customers while simultaneously needing money to take advantage of the next opportunity.
At this point, the owner has a decision to make. They can slow down, use accumulated cash, draw on another credit facility, bring in outside capital, or finance the receivables.
There is no universally correct answer. But ruling out factoring based on reputation alone can mean overlooking a financing option that may actually be the best fit for the business.
The Better Question Is What the Business Is Doing With the Money
I think this is where conversations about factoring can often go wrong. People focus heavily on the financing product and not enough on what the company intends to do with the capital.
Consider two companies using the exact same type of funding.
One has declining sales, shrinking margins and overdue obligations. It is factoring invoices because it desperately needs enough cash to make it through another month.
The other just landed a national customer. It has to increase production or payroll immediately, while the customer pays invoices 45 days later. The company factors those receivables because management would rather put the money back into growth than leave it sitting in accounts receivable.
Calling those companies financially equivalent because they both use factoring does not make much sense. The financing tool is only part of the story behind these businesses.
A line of credit can be used intelligently or poorly. So can a credit card, an equipment loan, venture capital or cash sitting in a checking account. Factoring is no different.
If the money being advanced against receivables produces profitable new business, helps the company accept contracts it otherwise could not support, or keeps working capital available for better uses, the financing can be part of a deliberate growth strategy.
Your Receivables Are Already an Asset
This is probably the simplest way to think about factoring.
If your company has completed the work and issued a valid invoice, you have created an asset. Your customer owes you money. The only question is when that asset turns into cash.
The Office of the Comptroller of the Currency describes accounts receivable as working assets that commercial borrowers can use to obtain financing. The SBA likewise describes invoice factoring as a way for businesses with outstanding invoices to convert a portion of those receivables into cash sooner.
Factoring essentially puts that asset to work earlier.
Instead of waiting for the full customer payment cycle, the company sells eligible invoices to a factor and receives an advance. Once the customer pays, the remaining reserve is handled according to the factoring agreement. If you want a deeper look at the mechanics, our guide to how invoice factoring works breaks down advances, reserves, customer payments and the overall funding process.
There are fees involved, of course. This is financing. But what matters is whether that cost makes sense compared with the opportunity the business is trying to pursue.
However, I think there is an important difference between looking at the cost in isolation and asking what access to the capital allows the business to do.
If receiving cash sooner costs money but allows a company to accept substantially more profitable work, the relevant calculation is not simply the factoring fee. The owner should also consider the opportunity that would have been delayed or declined without the funding.
Waiting Can Have a Cost Too
Business owners are usually very good at noticing financing costs because they are visible. The cost of not having enough capital is harder to see.
There is no invoice labeled “opportunity cost” that arrives at the end of the month for the owner to review.
This could look like a staffing company that stops pursuing larger accounts because it knows payroll would become difficult to carry. Likewise, a commercial cleaning firm could decline a contract it cannot comfortably finance. On the other hand, there are owners who might grow entirely from retained earnings, even though customers owe the company considerably more than it currently has available in cash.
None of those decisions are inherintly wrong. Growing more slowly and maintaining very little debt or outside financing can be an excellent strategy. But it should be a deliberate choice, made after weighing the financing options available to the business.
If a business turns down attractive new revenue because it does not have the working capital to support it, the financing cost is only one side of the calculation. What matters is the margin on the business, the risk involved, the cost of the funding and what other financing options are available.
Sometimes the answer will still be no. Other times, waiting is considerably more expensive than financing.
Good Companies Can Have Unfavorable Payment Terms
One of the strange things about B2B business is that landing a better customer can sometimes make your cash cycle worse.
Large companies often have buying power and may operate on longer payment terms than the smaller customers a business served when it was getting started. As a result, an owner can move upmarket, win financially stronger customers and end up waiting longer for payment.
That is hardly evidence that the business has deteriorated.
In fact, the quality of the receivable matters a great deal in factoring and other forms of financing. Factors typically evaluate the end customers responsible for paying the invoices, establish limits around those receivables and perform credit work as part of managing their exposure. OCC guidance describes invoice financing companies and the customer sub-limits they establish based on considerations including exposure, payment performance and credit strength. They go on to note that invoice factors may perform credit investigations and collections.
That is another part of the relationship that tends to get overlooked.
A quality factoring relationship is not just somebody wiring money every time an invoice is issued. Depending on the provider and agreement, the factor may be doing credit work, monitoring receivables and helping with collections while the client focuses on running the business.
For some companies, that support is useful even apart from the funding itself.
Setting Up Funding Before Crunch Time Changes the Conversation
There is one part of the old perception that can become a self-fulfilling prophecy.
If an owner believes factoring should only be considered when the company has run out of options, then that is when they might actually start considering invoice financing.
At this point, the company may genuinely be under pressure. Their payroll period is approaching, cash is tight and management needs something done sooner rather than later. That is not the ideal time to evaluate almost any financing decision.
A business that looks at funding while things are going well has room to compare providers, understand pricing, negotiate terms and decide whether the structure makes sense before money is urgently needed.
More importantly, management can plan around the funding.
This could be the case if the company has a major prospect that could double a division or a seasonal ramp is approaching. Perhaps an owner already knows that the next stage of growth will require more working capital than the current bank line provides.
Those are much better reasons to start the conversation. The financing becomes part of preparing for growth instead of something brought in to repair a crisis.
The Stigma Matters Less Than the Economics
I do not expect every business owner to love factoring.
There are situations where another financing option will be cheaper or better suited to the company. There are factoring agreements with terms an owner should look at carefully, and choosing the right provider matters.
That is precisely why the conversation should be about the economics of the financing rather than an old reputation attached to the word factoring.
What does the funding cost?
How much liquidity does it provide?
Can it grow with the company’s receivables?
What are the contract terms?
What additional services does the provider handle?
And most importantly, what is the business going to do with the capital once it has it?
Those questions tell you whether a financing relationship makes sense.
“Factoring is for struggling companies” does not.
Our guide to invoice factoring rates explains how pricing is typically structured and what can affect the rate a business receives.
Funding Growth That Has Already Been Earned
One reason I think factoring deserves a different reputation is that there is something straightforward about the underlying transaction. The business has already created the receivable and someone already owes the money.
Instead of allowing the customer’s payment schedule to determine when that capital becomes useful again, the company chooses to access a portion of it sooner.
For an owner trying to rescue a struggling company, that liquidity may provide breathing room. For another owner, it may fund the payroll behind a new contract, support the next large order or allow a sales team to keep pursuing business without worrying about whether existing receivables have cleared yet.
Those are completely different situations, but they all involve the same financial product.
So I would not argue that invoice factoring should always be the first funding choice, or even that it is right for every business.
I would argue for something far simpler.
Judge it the same way you would judge any other source of capital: by what it costs, how it is structured and what it allows the business to accomplish.
For the right company, factoring is not what happens after growth stops. It can be part of what makes the next stage of growth possible.
Sources
- Federal Deposit Insurance Corporation — Risk Management Manual of Examination Policies
Risk Management Manual of Examination Policies - Office of the Comptroller of the Currency — Accounts Receivable and Inventory Financing
Accounts Receivable and Inventory Financing - U.S. Small Business Administration — 5 Simple Questions to Help Determine Your Business Financing Options
5 Simple Questions to Help Determine Your Business Financing Options