Factoring is a tool that a minority of Business Owners have heard of. The ones that have are not enamored with it, but Factoring can be a good tool in a business that has issues with Cash Flow.
In particular, the best use of Factoring is covering the gap between expenses incurred on a project and being paid for a project. Let me use Construction as an example. Imagine you are going to do some renovations on a Commercial Office building. In this case, let us say that the Building requires a new roof. To get to the point where the job is complete, you need to buy and use materials. On top of that you have one or more crews that need to get paid for their time. After the job is complete, you send an invoice (maybe the net is due in 30 days or NET30). But the business is a bit slow in paying and you get a check between 45 and 60 days. Expenses for the project are likely to have started 90 - 120 days before you get paid.
Now, you will realize at this point that you are floating the customer a loan. Some industries (for example signage) often have down payments to cover materials but this is rarer than you might think. Even if the roofing job is wildly profitable, you might run out of cash waiting to get paid. So, how does factoring work and how does it help?
Well, factoring is a solution that is not a loan. In fact, it is a form of selling an asset. In this case, that asset is the Invoice that you are going to provide to the Customer. A Factor buys that invoice from you at a price less than face value. The Factor provides the cash to you up front and keeps a fee that represents the equivalent of Interest on the Invoice. The good news is that the Business' Credit Rating is not an issue, the customer's is. This means that a small company can get financing to deliver to a large customer.
In the long term, Factoring can be expensive. But it is the lifeblood of many industries and companies and smooths over any Cash Flow gaps that exist.
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