What is factoring?
Factoring accounts receivable is the practice of selling your business-to-business (B2B) invoices, at a discount, to a Factoring Company (also known as a factor) to free up working capital while waiting for payment. The factoring company provides you with an immediate cash advance and receives payment from your customers for the invoices.
What is the financial impact of factoring?
The financial impact is very similar to you giving a customer a discount for early payment. Factoring is a form of asset-based financing that does not create debt. It is NOT a loan.
How does factoring work?
Factoring companies buy your invoices and pay you for them in two installments. The process is simple and has three steps:
- You invoice your client after delivery of your product or services and send a copy of the invoice to the factor
- The factor advances a predetermined percentage of the invoice amount as a first installment
- When your customer pays, the factor will remit the remaining balance of the invoice amount to you, less a nominal factoring fee
Who qualifies for invoice factoring?
Invoice factoring can be used by most companies that engage in commercial or government sales. The three most important requirements are:
- Your company must sell to other businesses or to government entities
- Your customers must be credit worthy
- Your invoices must be free of liens
Why would you want to do this?
Factoring helps you speed up cash flow. The cash you get from a factor is unrestricted. You can use the money to pay bills, cover payroll, etc. If you’re a start-up or turnaround company, factoring is a practical way of getting the working capital you need. Factoring provides funds without the usual red tape, financial statements, credit history and personal guarantees that banks normally require.
How long will the application process take?
The application process can vary from company to company but generally factoring has one of the fastest turnarounds. Most factoring companies will move as fast as you can provide the documentation requested.
What if I have an outstanding loan?
A factoring company’s main concern is making sure that there are no liens on your accounts receivable. If you have already pledged your receivables as collateral for other loans, you should disclose this to the factor early in your dialogue. If your receivables are already pledged as collateral, the factor may still be able to help you but you need to disclose this early and not wait until the factor discovers the liens during due diligence.
What will my customers think, and how will they be treated?
Relax. Factoring is a huge industry. Small to large companies factor and your customers are probably already working with factoring companies through other firms they do business with. Remember that it’s in the best interest of a professional factoring company to keep your customers happy. The happier your customers are, the more invoices you will want to factor. We can help you find an established, professional factoring company with a good track record.
Do I have to factor all of my invoices?
No. Most companies pick and choose the customer whose invoices they want to factor. We always advise you to ask your factor about this before signing an agreement. However, the factors we recommend do not obligate you to factor all your invoices.
What kinds of companies’ factor?
Companies in every sector of our economy with business-to-business (B2B) invoices can be eligible to factor their invoices. If you’re strictly a retailer, factoring is not for you.
What do factors take as collateral?
Factoring companies will require a first line position on the invoices you factor. So, the invoices must be lien free.
Are there any other benefits to factoring?
In addition to freeing up capital, you also get back office support that will free up your time so you can focus on growing your business. For example, factors will check the credit of your prospective customers to help you make the best decisions pertaining to credit terms.
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