Navigating the Financial Landscape: Factoring as a Top Financing Option for Small and Medium-Sized Businesses in the US

Last updated on Jun 3, 2024

We have launched aqeel with small and medium-sized businesses (SMBs) in mind. SMBs are the backbone of the American economy, accounting for nearly two-thirds of all jobs in the country. However, access to capital can often be a challenge for these businesses, particularly in their early stages. According to a 2022 survey by the Small Business Administration (SBA), 20% of small businesses have difficulty obtaining the financing they need to grow.

Most SMBs rely on traditional financing options like bank loans and credit cards and do not tap into factoring for additional access to cash.

Traditional Financing Options: Bank Loans and Credit Cards

From our conversations with customers, bank loans and credit cards are among the most common financing options for SMBs. Bank loans offer larger sums of money and can be used for various purposes, such as purchasing equipment, expanding inventory, or hiring new employees. However, many SMBs simply don’t have access to bank financing for various reasons. For one, bank loans typically require a strong credit history, clean bookkeeping, and collateral, which can make them difficult to obtain for some businesses. Another reason, less obvious perhaps, is that SMBs often don’t have sufficient bandwidth to prepare the relevant documentation (accounts, business plan, etc.) or, worse, owners have used personal credit lines to fund the business, thus eroding their own credit quality.

Credit cards, on the other hand, are more readily available but often come with high interest rates – as high as 30+% APR - and the credit limit is significantly lower than a bank loan. This can make them a costly option for long-term financing, but they can be useful for short-term needs, such as covering unexpected, minor expenses. For purchasing inventory, however, this is not a means of financing simply because the interest is too high and because vendors accept credit cards in the rarest of cases.

Factoring: A Less Utilized but Potent Funding Source

Factoring, also known as accounts receivable financing, is a less well-known but potentially valuable financing option for SMBs. In factoring, a business sells its outstanding invoices to a factoring company in exchange for immediate cash. The factoring company then assumes responsibility for collecting the payments from the business's customers.

Factoring can be a particularly attractive option for businesses that have a high volume of invoices but experience delays in receiving payments from their business customers. By selling their invoices, businesses can access cash flow more quickly, which can help them meet payroll, pay suppliers, and invest in growth initiatives.

Did you know?

Despite its potential benefits, factoring is not widely used by SMBs in the US. According to a 2023 study by the International Factoring Association, only an estimated 10% of SMBs in the US utilize factoring. This underutilization is likely due to a lack of awareness of factoring and its benefits, as well as misconceptions about its costs and risks.

Why Factoring Can Be a Better Alternative

Factoring offers several advantages over traditional financing options for SMBs:

Faster access to cash: Unlike bank loans, which can take weeks or even months to approve, factoring provides immediate access to cash. This can be crucial for businesses that need to meet short-term obligations or seize unexpected opportunities.
Improved cash flow: Factoring can significantly improve a business's cash flow by converting outstanding invoices into immediate cash. This can help businesses avoid late payments, maintain inventory levels, and fund growth initiatives.
Reduced reliance on bank credit: Factoring can reduce a business's reliance on bank credit lines, which can be beneficial for businesses that have reached their credit limits or have poor credit histories.
Simplified collection process: Factoring eliminates the burden of chasing down late payments from customers. The factoring company assumes responsibility for collections, freeing up the business's time and resources to focus on other aspects of operations.
Avoiding Debt: Factoring or selling accounts receivable is classified as a commercial transaction rather than a financial one. For businesses with multiple lines of credit that cannot take on additional debt due to existing debt agreement covenants, factoring offers a great alternative. Since it is not recorded as a debt obligation on the balance sheet, it allows immediate realization of revenues without increasing debt.

Considerations for Factoring

While factoring offers several advantages, it's important to consider some potential drawbacks:

Fees and costs: Factoring companies charge fees for their services, typically by offering a discounted rate for the accounts they purchase. Although these fees may exceed the interest rates of traditional loans, the advantages of enhanced cash flow and decreased dependence on bank credit often outweigh these costs. Additionally, the fee applies only to a specific transaction for a limited duration, meaning there is no ongoing interest charge on unused funds. This contrasts with bank loans, where interest accumulates over time on the entire loan amount, potentially making the total cost of a bank loan significantly higher than the fee for a single factoring transaction. At Aqeel, we charge no origination or administrative fees. Instead, we have a single factoring fee that applies only for the duration you need financing. We disclose this fee transparently, allowing you to easily compare it to your next best financing option.
Loss of control over receivables: By selling their invoices, businesses relinquish control over their accounts receivable. This can be a concern for some businesses, particularly those that have close relationships with their customers. At aqeel, we have implemented mechanisms where you can benefit from everything that factoring offers but still maintain control over your accounts receivable.
Potential for credit score impact: Factoring can potentially impact a business's credit score negatively if the factoring company reports the invoices as "paid in full" to credit bureaus. This is because it may appear as if the business has settled its debts through external funding, which could affect creditworthiness. However, this impact can be mitigated by negotiating with the factoring company to report the invoices as "funded" rather than "paid in full" to credit bureaus. This distinction helps maintain a more accurate reflection of the business's financial activities and credit status. At aqeel, we report invoices as "funded" rather than "paid in full" to credit bureaus. This approach helps improve your business's credit score by accurately reflecting your financial management.

Conclusion

Factoring can be a valuable financing option for SMBs, offering faster access to cash, improved cash flow, and reduced reliance on bank credit. While there are some potential drawbacks to consider, the benefits of factoring often far outweigh these concerns. For businesses that struggle with slow-paying customers or need immediate cash, factoring can be a powerful tool to support growth and success.

aqeel offers factoring through its Early Pay product. Our process is completely digital, making it easy, transparent, and quick. Typical turnaround times for factoring decisions are just 24 hours. Sign up with aqeel today or contact us to learn more about how we can help optimize your business’s cash flow and build a strong credit history. Our tailored solutions are designed to support your financial growth and stability. Discover the benefits of partnering with aqeel and take the first step towards a more secure financial future for your business. You can sign up directly on aqeel or send us an email at hello@getaqeel.com.