What is factoring?
Factoring is a transaction in which a business sells its accounts receivable to a third-party commercial financial company, also known as a “factor.” This is done so that the business can receive cash quickly as opposed to waiting 30 to 60 days for a customer payment. Factoring is sometimes called “invoicing factoring” or “accounts receivable financing.”
The terms and nature of factoring can differ among various industries and financial services providers. Most factoring companies will purchase your invoices and advance you money on them within 24 hours. The advance rate can range from 80% to as much as 95%, depending on the industry, your customers’ credit histories and other criteria. The factor also provides your company back-office support. Once it collects from your customers, the factor pays you the reserve balances of the invoices, minus a fee for assuming the collection risk. The benefit of factoring is that, instead of waiting one to two months for a customer payment, you now have that cash in hand to operate and grow your business.
What are the advantages of factoring?
There are several reasons why factoring is a valuable financial tool for many businesses. The key benefit is that factoring provides a quick boost to your cash flow. Many factoring companies provide cash on your accounts receivable within 24 hours. This can solve short-term cash flow issues and help fuel the growth of your business. Factoring companies handle your customer collections, and may also evaluate your customers’ credit and payment history.
Other benefits include:
1. Factoring can be customized and managed so that it provides necessary capital when your company needs it.
2. Factoring is based on the quality of your customers’ credit, not your own credit or business history.
3. Factoring provides a line of credit based on sales, not your company’s net worth.
4. Unlike a conventional loan, factoring has no limit to the amount of financing.
5. The financing does not show up on your balance sheet as debt.
What kinds of companies use factoring?
Companies of all sizes use factoring. It is a common business practice across many industries. Factoring has a large presence in transportation, trucking, textiles, manufacturing, wholesale and distribution, oilfield services and staffing agencies. The factoring of receivables has a long history and some form of it is practiced in countries around the world.
Can my company factor even if though it is new and has no financial history?
Yes. Factoring is an excellent financing tool for start-up companies because it does not require a balance sheet or company credit history. The factor will base the financing more on your customers’ credit scores and payment histories rather than your own company’s finances.
How much of my invoices should I factor?
It depends on your company’s unique business needs. Some companies factor all of their invoices while others factor only invoices for customers that take a longer time to pay. The volume of receivables that a company may factor can range from a few thousand dollars to millions of dollars a month.
Is factoring similar to a bank loan?
No. Factoring is not a bank loan and you are not assuming any debt.
The emphasis is on your customers’ invoices, not on your balance sheet. Factoring provides a steady flow of funds whereas bank loans are often one lump sum. Factoring companies can also assist with the credit and collection functions, which help improve your company balance sheet. While bank loans add to your debt, factoring converts one asset (receivables) into another asset (cash). In many cases, bank loans can be difficult to obtain and are limited by your balance sheet.
How does the factoring process start?
In most cases, the factoring process is simple. When partnering with a factoring company, customers usually complete a short application form. After that, you may provide a current aging report and a few other basic documents.
What is the difference between recourse and non-recourse factoring?
Recourse means the factoring client ultimately takes the responsibility for the payment of the invoice.
Non-recourse factoring allows companies to sell their invoices to the factoring company, which assumes the credit risks for the collection of the invoice. Some factoring companies offer both recourse and non-recourse factoring.
What about fees or contract terms?
Different factoring companies have different fee structures. Some only charge an overall factoring fee that is determined by monthly volume and the creditworthiness of your customers. Other factoring companies have additional fees that cover money transfers, shipping, collateral and other costs of doing business. You should make sure the factoring company you work with is up-front and transparent about the fees it charges. Most factoring contracts also have an annual renewal term.
Is credit insurance needed on debtors?
Typically insurance is not necessary, but may be required in specific circumstances.