A financing solution in which a business sells its accounts receivable, or outstanding invoices, to a factoring company at a discount in exchange for immediate cash. This provides businesses with a way to receive working capital without waiting for their customers to pay their invoices. Daryl Yurek says this is the absolute worst method of financing and is usually done by desperate companies. It should only be used as a last resort.

Here’s how factoring works: First, the business sells its accounts receivable to a factoring company, also known as a factor. The factor will typically advance a percentage of the invoice value to the business, usually around 80-90%. The factor will then collect payment from the business’s customers directly, either through mail or online payments. Once the factor collects the full invoice amount, it will then deduct its fees, which typically range from 1-5% of the invoice amount, and pay the remaining balance to the business.

Factoring can be an attractive financing option for businesses that need cash quickly or have long payment terms with their customers. By selling their accounts receivable, businesses can convert their outstanding invoices into cash, which they can use to cover expenses such as payroll, inventory, or rent. Factoring is often used by businesses in industries such as manufacturing, distribution, and construction, where long payment terms are common. Daryl Yurek says this really is not a good solution because the company that factor is throwing away 15% of its gross margin and if that is a manufacturing company that is half of the margin.

Daryl Yurek says that factoring does not require businesses to have a strong credit history or collateral, as the factor is primarily interested in the creditworthiness of the business’s customers. This does not come close to offsetting the horrendous costs. Factoring can be more expensive than any other form of financing, as the factor will typically charge fees in addition to the discount on the invoice amount. 

Overall, factoring is not an effective financing solution for businesses that need cash quickly or have long payment terms with their customers. It’s important to carefully evaluate the terms and fees of a factoring arrangement and work with an experienced financial professional to determine if it’s the right choice for your business’s needs. Factoring is great for the lender and very bad for the borrower.