Factoring Explained – Get Connected with Cash

What is factoring???

As with all factoring companies we find ourselves being asked this question quite often. Many folks don’t understand this great way to provide your business with working capital. Basically, factoring is a type of business financing that allows businesses to sell their current accounts receivable invoices at a discount to a factoring company. We work with factoring companies nationwide to provide cash flow solutions that fits your unique needs. The factoring company, will provide 80-95% of the purchase price of the accounts with payback of a low percentage of the invoice total. Approval takes anywhere from 3 to 5 days for first time applicants with 24-hour or less turnaround time to get cash.

Factoring is not a loan so the money received does not go onto the businesses credit report and the businesses past credit history is not important for determining the eligibility of the business for this type of business financing, eligibility is determined soul from the businesses accounts receivable assess.

Those involved with factoring

• The Invoice seller - the business owners who want to free up cash
• The Factor -  factoring companies like InvoiceFactoringHQ.com
• Invoice payers - the debtor to the business

There are three primarily types of factoring offered by lenders

• Recourse Invoice Factoring
• Non-Recourse Invoice Factoring (Domestic Factoring)
• Export Factoring

*Each type of factoring offers its own benefits to the business.

Recourse Invoice Factoring

Recourse invoice factoring is financing against your businesses accounts receivable but would like to continue managing collections on your accounts. Customers would continue to pay directly to you and the lender would not be responsible for collections of the proceeds. As soon as your customers make the payments, your business would then submit the payment to the lender. This is the most common type of factoring used by businesses. With this type of factoring, the business that sells the invoices to the factoring agency will be liable to the factoring agency for any bad debt that occurs. In layman’s terms, if the customer does not pay the invoice the business is responsible for repaying the loan.

Non-Recourse Invoice Factoring

Non-Recourse Invoice Factoring (Domestic Factoring)  is also financing against your businesses accounts receivable as with invoice factoring. Rather than managing collections on your accounts you allow the lender to do so. This is a more preferred type of factoring because if the customer does not pay the invoice total the lender does not seek out the business that sold the invoice for the funds but they pursue to customer until payment is received. If the account debtor doesn’t pay, the factoring company takes the loss and you are not held responsible.

Export Factoring

Export factoring is financing against your businesses export receivables. This is a great way for businesses that do world wide sales to obtain working capital for their business. It holds the same terms and conditions to recourse financing most of the time, but flexible factors like InvoiceFactoringHQ.com can offer non-recourse invoice factoring.

How Factoring is Different from Bank Loans

There are several ways that factoring differs from bank loans. The factoring companies focus is on the businesses accounts receivables, this is the businesses financial asset.

There are several ways that factoring differs from bank loans. The factoring companies focus is on the businesses accounts receivables, this is the businesses financial asset. With a bank they will focus on the total value of the borrowing businesses assets to be placed as collateral such as inventory, equipment and realty. The bank looks at the overall credit-worthiness of the borrowing businesses, the factoring companies main focus is on the accounts receivables still. Unlike banks, the factoring company assumes all credit risk with the purchase of a business’s accounts receivables, this is a nonrecourse factor, there will be no collection of funds if the customer invoice is not paid, the selling business is not liable. Most importantly factoring is NOT a loan, it is the purchase of the businesses accounts receivables. The business is not borrowing and using their invoice as collateral, they are being sold at a discounted price.

Who is involved with Factoring

There are three main parties involved with factoring;

1. The business selling their accounts receivables
2. The debtor (customer of the seller)
3. The factor who is purchasing the receivables at a discounted price

Parts To The Factoring Transaction

1. The advance – This is a percentage of the invoice face value that is paid to the seller
2. The reserve – This is the remainder of the purchase price. These funds will be held until the debts account is paid in full
3. The discount fee – This is the cost of the transaction. This is deducted from the reserve with any other expenses and then remained is refunded to the seller.

The Process of Selling an Invoice (Receivable)

The debtor is liable to pay the invoice (receivable) to the seller, this is the financial asset of this process. One or more invoices (receivables) are then sold by the seller to the factor at a discounted price in exchange for cash. When the invoice is sold the ownership of the invoice is transferred from the seller to the factor along with all rights associated with the invoice. The factor then receives the right to collect payment made by the debtor for the invoice total. When an invoice is sold the debtor is typically notified of this sale. The factor then can begin to bill the debtor and make collections directly. If the debtor does not make payment on the invoice the factor must bear the loss of the account, this is nonrecouse factoring.

Who Uses Factoring?

Businesses of all types and sizes use factoring as a way of obtaining cash for their business without going through traditional lending methods. Rather than borrowing this capital they are selling funds that their business will receive in the near future at a discounted rate. This makes for a fast, easy and cost effective way of meeting business financial needs.
Common types of businesses using factoring include:

1. Product-based businesses:
   • Flower shops
   • Department stores
   • Hardware stores
2. Service-based industries:
   • Temp agencies
   • Landscaping companies
   • Commercial trucking firms
3. Medical Industry
4. Construction Industry

Why Do Businesses Use Factoring?

The objective of all businesses using factoring is to obtain cash for a wide variety of financial needs within the business. Many businesses determine if factoring is the right option for them with simple math. They are able to receive a percentage of the invoice upon sale, along with the time it will take to receive the full balance of the invoice waiting on the customers payment. They take these numbers and put them through a mathematical process to determine if this is a cost effective option for their business.

Pros and Cons of Factoring

On the surface, factoring often times appears to be a simple process that is full of benefits with no risk. However, this is not always the case.

Before getting involved with factoring on any level, it is essential to focus on both the pros and cons. This will help you better understand the finer details, including whether or not it can benefit your organization at the present time.

Pros

Upon getting involved with factoring, you no longer have to spend as much time chasing customers for payments. Subsequently, your organization will have more time to focus on more important tasks.

Additional benefits include but are not limited to:

• Quick cash flow boosts
• The ability to learn more about the credit standing of your current crop of clients
• A growing industry with a larger number of factoring companies competing for your business, ensuring the best possible terms

Cons

Even if the benefits of factoring pique your interest, you must learn more about potential drawbacks before moving forward.

In the past, one of the most common drawbacks was the long-term agreement required by the factoring company. While this has changed a bit over the last few years, it is still something to keep an eye on.

Due to the signing of a long-term agreement, many finding that breaking away from a factoring company can be a challenge.

Other drawbacks can include:

• Some customers may not want to deal with a factoring company, but instead want to pay direct as this affords a greater level of comfort
• The use of factoring can often times make it difficult to obtain other types of borrowing
• If you are interested in ending the contract (as discussed above), you are required to pay back any money that has been advanced if the customer has yet to make payment

Don’t believe the myth that factoring is an indication of financial struggles. Instead, consider the pros and cons based on your particularly company and the financial goals you are trying to achieve.