Let’s say you’re handy and you’ve got $10,000 saved up to start a company. You’ve invented a life-changing business tool called the Really Cool Thing that you can sell for $1,000. You rent a small production space, pay $2,000 for first and last month’s rent and pay yourself a $1,000-a-month salary.
In your first month you make and deliver four Really Cool Things – enough to cover expenses. Your product’s a hit and you get orders for twelve more, to be delivered in the next 30 days.
One snag: You only had $10,000 to begin with. You’ve already spent half. Rent is due. And you need $6,000 in raw materials to fulfill the new order. You’re $2,000 short and your customer on the first order won’t be paying you for at least 30 days.
With no operating history, your company isn’t a good candidate for a bank loan. You might be able to borrow from family and friends, but a loan has to be paid back. There’s an option that doesn’t involve borrowing or personal credit – invoice factoring. Here’s how it works.
An invoice factor will advance to you most of what your customer owes you. In this case you receive an advance that is more than enough, combined with your remaining cash, for you to fill your orders. You can get to work on filling new orders, and the factor will collect from your customer based on the terms you and your customer agreed upon.
There are lots of variations on this theme, but that’s it, in a nutshell. Cash today. Worries go away. Not too shabby.