Factoring Has Been Used by Businesses For More Than Four Centuries

In the world of finance, factoring is a transaction in which a business sells its accounts receivable to a third party — called a “factor” — in return for immediate cash.

How Factoring Works

With the assistance of a factoring company, businesses sell or borrow against their outstanding commercial accounts receivable. The cost is a fee often referred to as a discount — typically between 1-5 percent of the invoice or the amount borrowed. The accounts receivable are sold at a discount to the factor who in turn will collect from the party owing for the product or service provided by the business.

By factoring receivables, companies immediately benefit from improved cash flow; instead of waiting somewhere between 30 and 90 days or longer to receive payment, they will receive approximately 80-90 percent of the receivable in the form of an advance when the receivable is presented to the factor. In addition, the factor performs credit checks on customers to uncover any risks and help manage appropriate credit limits. Most factoring companies will also provide a follow-up service to assist with keeping the client’s customers paying more promptly.

Although commonly called a loan, factoring isn’t a loan; it’s the purchase of an asset, and in some cases the purchase can be structured on a Non-Recourse basis, in others it can be done with Recourse back to the company.

One thing to note is that factoring companies need to be more insightful about the inner workings of their client’s business than traditional lenders are. Since they are lending against their client’s outstanding receivables, it’s the factoring company’s job to know all about the client’s customers, terms, invoicing, and the billing process. Factors need to possess an in-depth understanding of their clients’ industries and the business nuances between their clients and the clients’ customers in order to be a positive partner for the client.

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Key Benefits of Factoring

In your search for commercial financing, here’s something to factor into your consideration — it may be time to look at factoring in a whole new light.

  • Obtain a source of working capital for growth
  • Relief from responsibility for collection of no-pay and slow-pay clients
  • Fill more orders
  • Flexible funding program that increases as you increase your sales
  • Ability to take advantage of vendor discounts
  • To have funds for payroll and taxes
  • Extend credit to customers on large orders
  • Buy equipment or inventory on demand

Is Factoring Right For Your Business?

Businesses engage in factoring because it’s a simple way to get money without having to prove creditworthiness, which in tough economic times can be difficult. It is especially tailored for start-up companies, companies with only a few years in business, and companies with erratic cash flows, tax issues, or customer concentrations. Factors usually deal with clients that are not considered “bankable” and help the company establish its own credit history and then assist the company to become a bankable credit.

Factoring is also easier and faster than getting a bank loan — with adequate documentation, a business should be able to get an approval in 2-5 days. Independently owned factoring companies are not regulated by the government which means they can take on higher risk clients. Factoring also lets business owners dispense with accounts receivable management, which often is biggest sources of frustration and expense for many business owners. They sell someone a product or service but have to wait weeks or even months to get paid. And there’s always the risk that the account won’t pay.

Factoring Myths

It’s unfortunate that, for whatever reason, factoring has gotten a bad rap. A lot of the myths about factoring simply aren’t true — for example, that factoring is too expensive to be considered a viable commercial financing option for the average small business. Most business owners view factoring through a tainted lens. That lens has typically been filtered by inexperienced bankers, CPAs, or lawyers. These sources of knowledge will often mistakenly compare factoring to bank loans. That is not the proper point of comparison.

In addition, most factoring companies don’t properly position themselves to either referral sources or potential clients. In truth, factoring can make the difference between success or failure for companies operating without adequate working capital — at a cost that’s probably a lot less than most business owners think. Just remember, companies don’t go out of business because of a lack of cheap capital; they fail because they don’t have “access to capital.”

Keys to Success with Factoring

Here are a few areas you should concentrate on in order to increase your chances for factoring success:

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