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Using Cash Advance and Factoring

March 27th, 2009 · No Comments

You should consider why you are seeking a business cash advance or factoring service before you contact any providers.  Both cash advance and factoring can be very expensive, and are less regulated than traditional financing options.  If you are able to seek other sources of funding, it is advisable that you do so before taking a cash advance.  Still, cash advances can be very valuable for businesses that need them. 

Before taking a merchant cash advance, you should evaluate how it will benefit your business.  Businesses that use cash advances effectively usually have a few common qualities.  Cash advances are best for businesses with at least a few of the following characteristics:

  • Lack of traditional options.  Some businesses do not qualify for a traditional loan, or might qualify, but can’t afford to wait for the approval and funding process.  Some businesses want to avoid a negative impact on credit rating, and choose to seek financing from sources that will not consult a credit report.
  • Predictable credit card sales volume.  Cash advances are best for businesses that have a steady, verifiable credit card sales pattern.  Because repayments are fixed as a percentage of sales, the amount will vary.  Businesses with a stable sales history are better able to absorb the repayment costs.
  •  New or service-based businesses.  Cash advances to not require collateral to secure.  Most new or service based businesses that don’t have any expensive assets prefer cash advances for this reason.
  • Seeking flexible repayment terms.  Repayment of a cash advance can be flexible.  Providers are often willing to extend terms, offer additional advances, or work with businesses on repayment terms even after an agreement is signed. 

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    The downside of cash advances is that they are expensive.  In some cases, rates can be quoted at up to 80%.  The average rate for a cash advance is usually between 25-35% for a cash advance of several thousand dollars.  Before you consider taking an advance, you need to make sure you have the resources available to pay back a large sum of money fairly quickly. 

    Factoring is another option for businesses that need immediate access to cash.  Factoring transactions are different from cash advances in an important way.  In a cash advance, a business is taking an “advance” on future sales.  In factoring, the sale has already been made, but payment hasn’t been collected.  This makes factoring less risky, so long as your customers usually pay their bills. 

    Businesses that can benefit from factoring usually have the following characteristics:

  • Spend significant time or resources on collection functions.  Hiring a factoring service is essentially outsourcing these functions.  The factor takes on the right to collect on an invoice, so your business is spared the expense of seeking payment.
  • Creditworthy customers.  Businesses that get the most from factoring are usually small suppliers to much larger companies, or companies with good credit and credible payment histories.
  • Large invoice amounts.  Most factors spend lots of time following up on invoices and contacting customers.  The best way to get maximum reward for this effort is to purchase high-dollar amount invoices. 

    • You can choose which invoices to sell, and can also sell portions of or entire customer accounts.  A business is never required to sell all invoices or receivables.  Once invoices are assigned to the factor, customers make payments directly to the factoring service, not to your business. 

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    This is beneficial if your customers were difficult to deal with, or paid bills late. However, it can be difficult to let another business take over a function as sensitive as billing and payment management for long-term or repeat customers.  After invoices are assigned, you are required to notify customers so that they can redirect payments.  Consider the impact that this might have on customer relationships.  Will your customers dislike the idea of dealing with a third party?  Will they question the financial state of your business, and maybe delay orders or worse, purchase from a competitor?  If you rely on customers for repeat business, you’ll need to evaluate whether using a factor could impact future sales. 

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