Q: I've heard a lot about factoring as an alternative financing source right now. How does this work?

A: Factoring is when companies sell their accounts receivable in exchange for a cash advance that's generally about 80% of the invoices outstanding. The "factor" — which might be a traditional lender or an independent factoring company — will then use the 20% or so portion kept on reserve to cover its fees and then return the balance to the business after all receivables are paid in full.

Fees on factoring tend to range from 2% to 6% of the invoice amounts, depending on how long it takes the factor to collect the client payments and the credit-worthiness of those clients, says Bert Goldberg, executive director of the International Factoring Association, a Pismo Beach, Calif., group with about 300 members. A business may have to repurchase an invoice from the factor if the client neglects to pay, depending on the factor's rules.

Factoring is generally much costlier than a traditional bank loan since a business might pay 3% of the invoices' outstanding amounts over a 30-day period to a factor, compared with, say, 8% or 10% interest annually on a bank loan.

Factors charge more than traditional loans, Mr. Goldberg says, because they have to do credit checks on all the clients whose invoices they buy and administrative work, such as billing clients.

Most companies turn to factoring do so because "they can't get money from a bank," he says.

Given the current credit crunch and the fact that many banks are denying businesses' loan applications or revoking credit lines, more small companies are turning to factoring as a way to shore up cash flow. Mr. Goldberg doesn't have any hard numbers, but "we're hearing that people are getting more inquiries right now," he adds.

Common businesses that use factoring include manufacturers, apparel makers, temporary-employment agencies, trucking companies and service providers such as dry cleaners. But any type of business with accounts receivables is eligible.

There are roughly 700 factors in the U.S. There's a free referral service you can find called "Factor Search" on Factoring.org, or by looking under "Factors" in the Yellow Pages.