Kabbage

Factoring helps small businesses get working capital by selling accounts receivable, or invoices, to a commercial financial company known as a "factor." The goal is for your business to receive cash more quickly than waiting for customer payments.

Factoring is very common in certain industries, such as the clothing industry, where long receivables are part of the business cycle.

How does factoring differ from a business loan?

Factoring is not a business loan – it's the sale of an asset (the invoice). Essentially, the factor is purchasing the right to collect on an invoice when it's paid, minus a discount of 2 to 6%. The factor will pay around 75% of the invoice up front, followed by the remainder once they've collected on the invoice.

So, how exactly does factoring work?

Because factors are counting on your customers paying their invoices, they are more concerned with your customers' financial status. Factoring companies will collect directly from your customers and may require you to validate your customers' payment history. If your business has creditworthy customers, factoring could help your business get working capital up front.

The key benefit of factoring is receiving quick boost in working capital, as many factoring companies will pay for your invoices within 24 hours. Since factoring is not a loan, you do not assume debt for the money you receive.