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What’s the Difference Between Bank Financing & Invoice Factoring?

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By Phil Cohen

There are two specific occasions when a business owner typically runs into a cash flow problems.  The first is when the company is just starting out, and the second is when it starts growing rapidly. Unfortunately for the business owners, banks are not willing to extend credit in either situation. However, there are factoring firms who will work with companies in both circumstances, and it’s a cash flow consultant’s responsibility to explain why.

New Businesses Don’t Have Enough Collateral

Startups have an especially hard time being approved for a bank loan because they lack two vital attributes.  First of all, a startup company does not have any tangible assets to secure a loan.  In fact, the company’s primary asset is its accounts receivables, which unfortunately is not concrete enough for a bank because those can disappear quickly and without notice.  Banks look for assets that are more tangible such as real estate, machinery or equipment-something physical that they can seize in the event of default.

On the other hand factors provide cash based on the quality and liquidity of a company’s assets, specifically their accounts receivable.  In the event that a new company was to go out of business, a factor can rest easy because it knows that it can still collect on invoices that were issued prior to the business closing

Failure Rates for New Businesses Are Too High

The second area that could prevent a new company from obtaining a business loan is that banks traditionally will not consider loaning to companies who have been in business for fewer than three years because of the high failure rate for new businesses.

Once again, factoring companies have a different approach to funding new businesses and they are not so easily swayed by one that is just opening its doors.  Cash flow consultants should stress to these entrepreneurs that factors consider the quality of the new company’s accounts (the credit-worthiness of their customers and the validity of their invoices). Furthermore, factoring firms see a different picture when investigating the credit-worthiness of their clients’ customers.  Cash flow consultants should also encourage their clients to sell goods to or provide services for entities that have a good credit history in order for factors to gain comfort that they will be paid for the invoices that they buy. (NOTE: This is a smart strategy that all new business owners should consider adopting regardless of whether they factor.)

Growing Companies Don’t Have Enough Profitable History

As noted previously, another time when entrepreneurs find themselves in need of cash is during a rapid growth period.  More often than not, a growing company goes to a bank looking for a larger loan than what last year’s earnings could justify because they intend to use the loan to double or triple last year’s revenues. 

For example, a temporary staffing company may have landed a contract with the area’s biggest hospital, and they need to hire and staff an additional 20 nurses immediately.  The agency might have enough money to recruit nurses to fill the demand, but it might not have enough readily available cash to pay their nurses once they have completed their shifts.  This situation is quite common in the medical staffing world because business owners are expected to invoice and make payroll on a weekly basis while the medical facilities they staff regularly can take up to three months to pay for those shifts.

This scenario puts a growing temporary staffing company in an awkward limbo where its previous income and cash flow is much smaller in comparison to its increasing need for financing. Now most banks wouldn’t feel comfortable loaning money to a company based solely on its potential to grow.  Rather, banks consider a company’s ability to repay a loan based on its historic earnings. So the bank lending process eventually turns into a never-ending cycle-the company needs money to grow, but the bank needs to see a history of growth before it’s willing to give money.

Factors, on the other hand, view this type of situation in a completely different light.  Though a factor will look into a growing company’s operating history, it’s not a deal killer if the company doesn’t have a track record of high earnings. Where a bank is more concerned with the past, a factor is generally more concerned with the future of the business.  Furthermore, going back to our example, the fact that the medical staffing agency just signed a contract with one of the biggest and fastest paying hospitals in the area means nothing to a bank, but it is great news for a medical staffing factoring firm.

In summary, companies who are just starting out or have begun to expand quickly can be approved for factoring even when banks have already turned them down because the lending criteria differs. However, most business owners don’t understand the differences. So cash flow consultants need to take the time to explain those differences. Doing so will surely help your clients see that factoring is a good alternative financing option.

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Phil Cohen

About the author

Philip Cohen is the founder and President of PRN Funding, LLC. PRN Funding is an extraordinarily focused niche player in healthcare funding. With years of…... Read More

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