Alternatives to Factoring
There are always alternatives to factoring. These alternatives should at least be considered when making a financial decision.
Alternatives to Factoring
For the seller or supplier, the alternatives to factoring can fall into two major categories. Either you can eliminate the cash flow problem or you can solve it through a more conventional method. The first is fairly simple on paper, but not as easy to do in the real world of business. If all customers are expected to pay at the time of delivery and accounts receivables are held to an absolute minimum, there is no need for factoring. It should be noted that this could easily lead the company into an unfavorable competitive position against companies offering more generous terms of sale.
Conventional business financing can be used as one of the alternatives to factoring. If it is possible to get a start-up loan or a revolving line of credit that is sufficient to handle any short term cash flow problems, this could be seen as an alternative. In many cases, it is the rejection by conventional lending institutions that leads a business to a factoring company in the first place. When it is possible to get conventional business financing, why would one chose factoring?
There is an answer. A conventional loan has a repayment expectation based on future performance. A company makes a loan, for instance, purchases inventory, and begins to sell it off. A portion of the revenues of the sales would be designated to satisfy the loan repayments. This works fine as long as sales meet expectations. If they do not, the business just has increased debt and hurt their cash flow positions as the repayment funds would have to come from elsewhere. At least when the factoring method of financing is used, the “loan” is being prepaid by already existing sales and not future expectations that may or may not come true.
The Small Business Administration sponsors some loan programs that are intended to help small and new business avoid the need for factoring. They do this by offering a program called the Small Asset-based CAPline or SMBA. This program helps the small business owner get a revolving line of credit that is secured by assets that they actually have rather than anticipated sales. This is a good program and it certainly can help a new small business owner set up a revolving line of credit type account. It still is not based on sales already in the books though, and so the risk to the assets that are securing it still exists.
There are plenty of alternatives to factoring. It is rarely something that is done because absolutely nothing else can be attempted. There are times and situations where it is the best and most sensible way to go. A good business planning process will recognize and be aware of alternatives in every step. Factoring is just another example, and when it is the right solution, knowledge of the alternatives will just help point you in the right direction.