Alternatives to Factoring: Other Options for Accessing Working Capital 

Using a factor is a fairly common practice, but it may not be the right option for your company. 

Using a factor is a fairly common practice, but it may not be the right option for your company. 

In a world where many companies struggle to access working capital, especially if they’re smaller and newer, factoring can help them quickly boost cash flow. Factoring is relatively accessible, too: According to the most recent C2FO Working Capital Survey, 54% of respondents said they had the option to use a factor. But it’s not the best option for everyone. Depending on a company’s circumstances, it can help to have alternatives to factoring.

In this article, you’ll learn more about factoring, including: 

• How it works
• The advantages of using factoring
• The potential drawbacks
• Alternatives to factoring

What is factoring? And how does it work? 

Factoring (also known as invoice factoring) is a type of financing where businesses sell their customer invoices to a third-party company known as a factor. 

The factor advances a portion of an invoice’s full amount to the business almost immediately. This advance is usually worth 70% to 90% of the full invoice, and it provides the business with a quick injection of cash. The business doesn’t have to wait weeks or months for its customers to pay up.  

The factor then collects the full amount of the invoice from that customer by the original due date. Once the customer pays, the factor gives the business the remaining 10% to 30% of the invoice — minus the fees charged by the factor, which usually range from 1% to 5%. 

What are the advantages of factoring? 

Factoring consistently received high marks from respondents to the Working Capital Survey, which included business leaders and financial professionals in the US, the UK and India. 

• 87% said factoring is easy to use.
• 85% said it integrates well with their payment systems.
• 84% approved of how much funding they were able to access.
• 81% approved of the cost associated with factoring.

The biggest benefit of factoring is that it provides increased cash flow fast to businesses that might not have another easy way to access working capital. That payment could make a huge difference for the companies that receive it, allowing them to take advantage of bulk-ordering discounts or deal with temporary shortfalls in cash flow. 

Factoring may also be more accessible to businesses that don’t have an extensive credit history. The factor may care more about the creditworthiness of the customers that have to pay the invoice.

And it can also be faster to deal with a factor than to get approval from a traditional bank. 

What are the potential disadvantages of using a factor? 

It’s true that factors can be more flexible than a traditional lender, but many come with their own requirements that could conflict with your company’s goals and preferences. 

• It could affect your customer relationships. If an invoice isn’t paid, the factor may take charge of collections. This isn’t true for all factors, but many insist on handling the outreach to late payers and nonpayers. How they handle those conversations could impact relationships that your company spent years building.
  
• Their fees aren’t always clear. While factors charge a fee for their services, many also have a range of additional fees, like charging for ACH payments or invoice uploads. It’s important to make sure that you’re aware of all the potential fees and how they work.
  
• The factor may insist that all your invoices flow through its system. You may not have to request advance payment on all those invoices, but the factor wants the payments on those invoices to land in its lockbox banking account.
  
• The factor might want a long-term commitment or larger invoices. Some factors support one-off or spot factoring, but most prefer contracts of several months. They also prefer to advance cash on a few larger invoices than a string of smaller ones.  

Here are some other potential “gotchas” to keep in mind. 

Examples of factoring alternatives 

Dynamic discounting

Dynamic discounting is an early payment solution that allows companies to receive payment faster in exchange for granting a small discount to their customers. Unlike a traditional static discount, such as 2/10 net 30, the size of the discount and the timing can vary. Generally speaking, the bigger the discount, the earlier the payment. 

At C2FO, our Early Pay solution runs on a dynamic discounting model. Enterprises use our platform to create marketplaces where their suppliers can request faster payment. Enterprises set a target return — usually expressed as an APR — for the size of the aggregate discount they want. Individual suppliers choose the size of the discount they’re willing to pay. 

The C2FO platform’s proprietary algorithm will then select the discount offers, taken together, that meet the enterprise’s target. Those offers are approved for early payment.  

Supply chain finance (reverse factoring)

Many enterprises offer supplier finance programmes that help their partners to receive payment earlier. The suppliers are usually required to offer some kind of discount in exchange for the early payment.

These programmes are usually (but not always) operated by a bank that funds the early payments. The enterprise pays the bank back on the original due date, or later, if they negotiate a different date. 

Lines of credit

With a line of credit, a lender allows a business to borrow up to a certain amount whenever funds are needed. The business only pays interest on the amount actually borrowed, plus certain fees. For a business seeking flexibility in its financing, a credit line can be a great choice.  

Lines of credit are secured or unsecured. A secured line means the borrower has put up collateral, such as real estate or receivables, that can be seized in the case of nonpayment. Instead of collateral, an unsecured line is based on the borrower’s creditworthiness. Because there’s less risk with secured lines, they tend to have lower interest rates and higher credit limits.

Business loans

This is what most people envision when they talk about borrowing money from a bank. The lender provides a sum of money up front, which the borrower repays in installments over time. In addition to being creditworthy and meeting other underwriting standards, the borrower is almost always required to put up collateral.

Compared to a line of credit, bank loans usually involve greater amounts of money, but while a credit line can be used for almost anything, a lender will want to know how the bank loan will be spent. 

Business credit cards

Business cards (which are designed for a wide range of businesses, including sole proprietorships) and corporate cards (which are built for larger businesses) can help companies access liquidity without a long wait. 

These cards typically have a larger limit than an individual’s credit card, and many of them can track and control spending — perfect for businesses that want to ensure their employees don’t go over budget. 

The cards also have conditions that may not work for your organisation. If a business card has a negative payment history, that will be reflected on the owner’s personal credit history. Corporate cards, which are harder to acquire, must be paid off every month, and many have minimum spending requirements. 

Merchant cash advance

A merchant cash advance is a financial product where a business receives cash up front against its future sales — usually its credit and debit card sales. It comes with some truly ugly drawbacks for businesses. 

For companies that need a short-term infusion of cash, this type of product could help cover a shortfall. Funding is usually fast, and repayment often happens as a percentage of sales. So, if sales are a little low, the required payment will be lower, too. (Some advances are repaid through fixed payments.)

But companies need to keep their eyes open when considering this type of financing.

The cost is monstrously high compared to other sources. Instead of an interest rate, the cost of cash is calculated using a factor rate like 1.2 or 1.5. If you borrow $20,000 and the factor rate is 1.4, then you would need to repay $28,000, not counting other fees that might be charged. 

Repayment usually happens on a daily or monthly basis because the advance company will pull funds directly from your account. There’s a nonzero chance that it could push your company into a cash shortfall. 

Plus, the providers of merchant cash advances also have a bad reputation for extremely aggressive collection practices.

The bottom line on factoring alternatives

C2FO offers solutions that let companies access working capital affordably and quickly, without the fees and frustrations of other financing. Learn more here.