Alternative Financing: What Is Factoring and How Does It Work?

There are other ways to secure capital for your business besides taking out a loan. While many business owners do, in fact, use loans, alternative financing options offer some unique benefits. Factoring, for instance, is a popular alternative financing option. You can use it to secure capital without taking out a loan or otherwise incurring new debt.

What Is Factoring?

Receivables factoring, or what’s more commonly known simply as factoring, is a form of business financing that involves the sale of accounts receivable to a third party. Businesses that have unpaid invoices can sell them to a third party. The third party will purchase a business’s unpaid invoices, after which it seeks to collect payment from the business’s customers or clients.

How Factoring Works

It may sound complex, but factoring is a simple and straightforward financing option. If your business uses invoices — meaning you send customers or clients a bill after their products or services have been delivered — you can sell some of those unpaid invoices to a third party. Third-party companies that purchase unpaid invoices are known as factoring companies.

For a fee, a factoring company will purchase your business’s unpaid invoices. If you have $100,000 in unpaid invoices, a factoring company may offer you $90,000. All factoring companies charge a fee. That’s essentially how they make money. By using their services, though, you won’t have to collect payment. Rather than contacting customers or clients to seek payment, you can sell those unpaid invoices to a factoring company.

Factoring vs Loans

Factoring is a completely different form of financing than loans. Loans are considered debt financing. Some loans are unsecured, meaning they don’t require collateral. Other loans are secured, meaning you can only obtain them with collateral. Regardless, they all involve debt. If you use a loan to finance your business, you’ll incur new debt.

You won’t incur new debt with factoring. Factoring isn’t considered debt financing because it doesn’t involve borrowing money. Instead, it’s a financial transaction between your business and a factoring company. After selling unpaid invoices to the factoring company, you’ll have fresh capital on hand with which to finance your business. You won’t have to pay back the capital. Factoring is a popular alternative to loans, as well as other forms f debt financing, because it doesn’t involve borrowing money.

What are your thoughts on factoring? Let us know in the comments section below!

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