The right funding depends on why you need cash, how long you need it and who your customers are. This chapter helps you sort out whether factoring fits, and what else to consider.
When factoring tends to fit
Factoring is often a good match when most of these are true:
- You sell to businesses or government agencies on payment terms such as net 30, 45 or 60.
- Your customers pay reliably, even if slowly.
- The cash gap is the problem, not profitability. You make money on each job but wait too long to collect it.
- You are growing and need funding that rises with your sales.
- You do not qualify for a bank line yet, or you need cash faster than a bank can provide it.
- Your margins can absorb the cost. After fees, each job still leaves you a profit.
When factoring may not fit
Factoring can be a poor match when:
- Your customers are consumers. Consumer invoices generally do not qualify.
- Your margins are thin. If fees would wipe out your profit, factoring may only speed up losses.
- Your invoices are often disputed. Disputes delay funding and trigger buybacks.
- Your problem is not timing. If sales are falling or the business is losing money, faster collections will not fix the cause.
- You need cash before you have an invoice. Factoring needs a completed sale.
- Your receivables are restricted. Some federal contract and Medicare or Medicaid receivables have assignment rules that limit factoring.
- You need a small amount once. Setup costs may not be worth it for a single small need, though spot factoring can help in some cases.
Alternatives to factoring
Each option below has a different purpose. None is right for everyone.
Business line of credit
A revolving credit line lets you draw funds and repay as needed. Banks usually look at your business credit, financial statements, cash flow and collateral. When you qualify, a bank line often costs less than factoring. It can take longer to obtain and may come with covenants.
SBA CAPLines
CAPLines is part of the SBA's 7(a) loan program. It is designed for short-term and cyclical working capital needs. Loans are made by participating lenders and partly guaranteed by the SBA. There are several types, including lines for seasonal needs, specific contracts, builders and general working capital. SBA lenders follow SBA rules on eligibility and documentation, so expect a fuller application than factoring.
Purchase order financing
Purchase order financing pays your supplier so you can fill a confirmed customer order. It is used before an invoice exists. When the order ships and you invoice the customer, the PO funding is often repaid from factoring or from the customer's payment. It is typically used by distributors, resellers and businesses that sell finished goods.
Asset-based lending
Asset-based lending is a loan secured by receivables, and often inventory and equipment. Your borrowing base rises and falls with those assets. You usually keep collecting from your own customers. These loans tend to suit larger, established businesses with solid reporting systems, and they often require regular audits and borrowing base reports.
Merchant cash advances
A merchant cash advance provides a lump sum in exchange for a share of future sales or bank deposits. Repayment is usually automatic, often daily or weekly. Approval can be quick and is based mostly on your sales history. Because they are structured as purchases of future receipts rather than loans, the total cost can be hard to compare. Convert any offer to a total dollar cost and check whether it files a UCC lien that could block other funding later.
Other options
- Early payment discounts. Offer customers a small discount to pay sooner.
- Supplier terms. Ask vendors for longer payment terms to narrow your gap.
- Customer deposits. Ask for partial payment up front on large orders.
- Equipment financing. If the need is a truck, machine or vehicle, a loan secured by that asset may be a better match.
Questions to ask yourself
Before you apply, work through these:
- Why do I need the cash? Timing gap, growth, a single big order or a loss?
- How long will I need it? A few months, or as an ongoing part of how I run the business?
- Who are my customers? Businesses or agencies with steady payment history?
- What are my margins? After fees, does each job still make money?
- How often are invoices disputed? Can I fix that first?
- Do I have existing liens? Will my current lender cooperate with a factor?
- Am I current on taxes? Especially payroll taxes.
- How will my customers react? Have I talked with key accounts?
- What is my exit plan? Will I move to a bank line once I qualify?
- Have I compared total costs? On the same invoice, same time frame, all fees included?
If your answers point toward factoring, the next chapter gives you a checklist of questions to ask any factor before you sign.
Frequently asked questions
Can I use factoring and a bank line at the same time?
Sometimes. The bank usually needs to release or subordinate its claim on receivables, or sign an intercreditor agreement with the factor. Many banks will not, so ask early.
Is factoring a long-term solution?
It can be. Some businesses factor for years because it matches how their industry pays. Others use it as a bridge until they qualify for cheaper credit.
How do I compare factoring with an SBA loan?
Look at total cost, speed, documentation and flexibility. SBA-backed credit often costs less but takes longer and requires more paperwork. Factoring is usually faster and easier to qualify for but costs more over a year.