Factoring Explained in Full
Over a decade ago our Nation’s economy took a turn for the worst. Thousands of small, medium and large businesses began to face financial difficulties, sending them in search for funding. While many businesses failed due to the economic downturn, others were able to survive and succeed with thanks to nontraditional financing options, such as Factoring. With traditional banks and lending institutions tightening their requirements the average or less than perfect businesses are unable to get the funding they need to succeed. Factoring has taken away to fear of denial, offering funding to nearly all businesses.
What is Factoring?
Factoring is the process in which businesses with accounts receivables, invoices in collections, can receive funding on future payments by selling them to a factor (the business offering this type of funding). These businesses selling their accounts receivables are able to receive 70% to 85% of their invoice totals before customers pay with this sale. These invoices traditionally are paid within 30 days at its maturity date, at this time the factoring will collect the advanced or purchased amount with any fees or interest that accrued on the funds, any remaining capital will be returned to the business unless specified otherwise.
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;
- The business selling their accounts receivables
- The debtor (customer of the seller)
- The factor who is purchasing the receivables at a discounted price
Parts To The Factoring Transaction
- The advance - This is a percentage of the invoice face value that is paid to the seller
- The reserve - This is the remainder of the purchase price. These funds will be held until the debts account is paid in full
- 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:
- Product-based businesses:
- Flower shops
- Department stores
- Hardware stores
- Temp agencies
- Landscaping companies
- Commercial trucking firms
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.
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
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.
About Michael Mesa, and Factoring.net
Michael Mesa is known as one of the top factoring professionals. He has been involved in the financial services sector for over 25 years.
Mr. Michael Mesa graduated from the University of Miami, with a masters degree in Economics. He has a series 7 and series 12 license in the State of Florida, and the State of New York.
Factoring.net is a non-promotional website built to help guide business owners with simple and straight-to-the-point facts about financing.
The website, and Michael Mesa have received a large amount of recognition, and support. All of which is great appreciated.
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