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The Pros and Cons of Factoring

When you sell your accounts receivable to a financial institution, financing costs can exceed 20%, but that's better than no financing at all

The breakdown in the credit markets clearly isn't limited to the financial industry itself (BusinessWeek, 10/02/08), and some businesses (BusinessWeek.com, 9/26/08), particularly owners with bad credit, unproven ventures, or companies tied to troubled industries, are having difficulty. As a result, there is heightened interest in alternative sources of financing, which can range from peer-to-peer loans (BusinessWeek.com, 12/21/07) to businesses securing money from their own customers (BusinessWeek.com, 5/5/08).

Another option I've been getting a number of questions about is a type of internal debt financing known as factoring. Simply put, this is when a company sells its accounts receivable to a financial institution or investor known as a factor. While factoring has been around for hundreds of years, the traditional banking industry considers it a backwater for struggling companies—mainly because financing costs on factoring can easily exceed 20% of the value of the receivables. And let's face it, banks usually focus on mature companies that have solid asset bases.