Factoring and Business Risk

A recent survey of business owners by the NFIB has gotten a lot of attention. It showed that small business owners are pessimistic about the current state of the economy. Other data suggests that small business lending is down (This article is exceptional, please read) due to the expiration of stimulus measures that offered 90 percent guarantees on SBA loans. Although there may be new legislation to return guarantees to 90 percent, it may take some time before it becomes effective. There are also talks of a double dip recession that could undo the recovery process and send us into another recession.

With the current uncertainty, managing business risk is of utmost importance. Survival is the name of the game right now and adding operational expenses is only for the ultra-confident or extreme risk-takers. This is why it is a great time to consider factoring as opposed to bank loans to finance operations. Bank loans create a liability that adds to operational expenses. This fixed obligation could become a burden when cash flow gets tight, thus it creates financial risk. Factoring, on the other hand, creates no new debt and thus no new financial risk. On the contrary, factoring is more akin to the sale of an asset. You ‘sell’ all, or a percentage of your receivables and receive cash for business operations immediately. I say ‘sell’ because factoring is technically an assignment; a factor buys the rights for a payment on a receivable. This means the customer bears the obligation to make good on the receivable, while you use the money for day-to-day operations. This means that factoring creates no new financial obligation and thus no new financial risk.

Factoring is also good for this uncertain economic climate as it is a very flexible financial arrangement. Because factoring amounts to a short term cash advance, it is easy to adjust the amount of financing needed at any given time. If the economic climate changes, factoring can be cut-off or increased depending on what is best for the new situation. The same cannot be said for a standard bank loan; businesses are locked into terms no matter what happens with the economy. Using factoring in this uncertain climate is a good way to stay aggressive but still hedge your bet.

Factoring can actually help reduce certain risks a business is exposed to, specifically the risk of non-payment from a customer. This is because factoring companies run credit checks on all of their client’s customers. This provides valuable insight on the financial position your customers are in. Offering trade credit to businesses that are not credit worthy is a very risky proposition which becomes all the more risky if the economy gets worse. Factoring can provide the information to make informed decisions that will help manage risk exposure.