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Is Factoring a Funding Option for Your Small Business?

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Sol Roter, Founder and Director of Liquid Capital Corp., contributed this article to BusinessNewsDaily's Expert Voices: Op-Ed & Insights.

In today's economy, it's harder than ever to secure small-business loans from banks and other traditional lending sources. What's worse, many business owners are struggling to make ends meet on their own, unable to take advantage of expanding market opportunities. The demand for small business financing is very high. In December 2012 for example, less than 15 percent of small business loan applications  were approved, although the National Small Business Association reports that one in four businesses lack the capital necessary to move their companies forward. Lost growth opportunities are the highest costs borne by businesses with inadequate working capital financing.

Fortunately, there are alternative options for business owners in need of immediate funding. Chief among them is factoring, which involves the purchase of corporate accounts receivable by a factoring company. Only about three percent of business owners know that factoring is an option, but for many companies, it can mean the difference between fighting to stay afloat and having the money to take advantage of opportunities and grow the business.

Here's how factoring works: say a business has $100,000 in accounts receivable outstanding. There is a gap between the collection of the accounts and the needs of the company to pay salaries, suppliers and the costs of new projects. Before the credit crunch, the business might have gone to a lender and received a loan backed with the accounts receivable. Today, though, those loans are much harder to come by. That's where a factoring company comes in. By purchasing those outstanding invoices, factors can provide timely funding to help businesses make payroll, complete projects or expand operations.

Generally, any business-to-business company that has the ability to increase their sales but is held back by a lack of capital can benefit from factoring. The industries that tend to use factors most frequently are service-based because they have a high labor component and must pay employees weekly, but accounts receivable collections are on a different and longer schedule. Without factoring, these companies wouldn't be able to expand.

[Read related article: A Guide to Choosing the Right Small Business Loan]

The biggest advantage of factoring is its rapid turnaround. Typically, businesses can get funds within 24-48 hours for approved accounts. Factoring helps businesses in countless ways: balance sheets become more attractive, financial positions are solidified, cash flow is enhanced, late penalties and fees can be eliminated, discounts from suppliers can be earned, and credit ratings improve. These improvements can put the company in a better position for future opportunities.

Factoring differs from traditional bank loans because the credit decision is based on the quality of the receivables rather than other criteria – how long the company has been in business, financial ratios and personal credit scores, for example – that a bank would take into consideration. Factoring differs from equity financing in that factors don't take equity in the company and do not interfere in management. Since contracts are short term, the client could elect to stop factoring whenever they choose.

Factors have fought a stereotype for years, one that assumes they are a last resort or the business equivalent of payday lending.

In reality, owners of factoring businesses provide their clients with many helpful services to keep their business healthy. A factoring facility provides funding that grows directly with a business's sales as opposed to a bank line that is capped with only periodic revues. In addition, factors provide professional information to set credit limits for customers, comprehensive accounts receivable, management and reporting systems, and efficient collections services – tasks frequently neglected or inadequately performed by most small businesses.

Each company's cost of factoring is based on their risk, industry and market position. For companies that struggle to secure bank lending and need additional capital to make ends meet or take advantage of growing market opportunities, factoring may be the ideal time- and cost-effective solution.

If you have a chance to grow your business but lack the necessary capital, your competitors will step in and you will miss a growth opportunity. If that's the case, what is a flexible working capital solution worth?

The views expressed are those of the author and do not necessarily reflect the views of the publisher.