What Is Accounts Receivable Factoring? And Why Most People Misunderstand It
Accounts receivable factoring is one of the most misunderstood financial products in business. People hear the word factoring and think it’s a loan. Others assume it’s a last resort for desperate companies, or some modern financial gimmick designed to extract fees from small businesses.
We’ve been in factoring since 1994 and our team has funded over $7 billion in receivables. Here’s what accounts receivable factoring actually is.
The Simple Version
You run a business. You complete work or deliver a product. You send your customer an invoice. That invoice is an asset on your balance sheet representing money your customer owes you.
The problem is your customer doesn’t pay for 30, 60, sometimes 90 days or longer. In the meantime, you’ve got payroll, materials, rent, insurance, and a dozen other expenses that don’t wait.
Factoring solves that gap. You sell your invoice to a factoring company and receive funding against it right away. When your customer pays the invoice, the transaction closes. No loan on your books and no equity given away. You’re converting an asset you already own into cash you can use today.
What Factoring Is Not
Factoring is not a merchant cash advance. An MCA lends against your future revenue, which is speculative. Factoring purchases a receivable for work you’ve already completed. An MCA adds debt and starts pulling money from your bank account daily regardless of your cash position. Factoring matches your actual business activity.
Factoring is not debt either. You’re selling an asset, not borrowing against one. Your balance sheet doesn’t get heavier. In many cases it gets cleaner because good factoring companies require your payables to stay current as part of the funding process.
And factoring is not a sign that your business is failing. Some of our clients have been with us for over 20 years. They use factoring because it matches how their business operates. We’ve had companies use factoring during a growth phase, then sell their business for a multiple of revenue with their equity fully intact.
Why Businesses Use It
The most common reason is growth. When a company is growing, it needs more cash than its current operations generate. Banks look at your last two years of tax returns and make a decision based on where you’ve been. Factoring looks at the invoices you have right now and funds against where you are today.
Construction subcontractors use factoring because they complete work months before they get paid by general contractors. Staffing companies use it because they pay employees weekly but invoice clients monthly. The underlying pattern is the same. A company has a real receivable from a real customer for work that’s already done, and factoring turns that receivable into cash without adding debt or giving up ownership.
How Credit Decisions Work
The credit decision is based primarily on your customer’s ability to pay, not yours. If you’re a subcontractor invoicing a Fortune 500 general contractor, the risk to the factor is low because that GC has strong credit and pays reliably. Your personal credit and business history matter too, but the strength of your customer is the primary driver.
At DARE, we go further than most factors. On construction deals especially, we underwrite the entire project chain from the owner down through the GC and the subs below. We pull from five different credit databases and monitor projects in real time. That level of diligence is why we’ve maintained a failure rate under 1% for over three decades.
The Oldest Form of Finance
Factoring predates modern banking by thousands of years. It’s been around since ancient Mesopotamia. London merchants shipped goods to the New World on credit, and factoring is what financed the American colonies. The mechanics have evolved, but the core of it hasn’t. You did the work. You’re owed the money. Factoring gets it to you faster.
Schedule a consultation with DARE Business Capital. We’ll look at your receivables, your customers, and your situation and tell you straight whether factoring is the right fit.