Factoring - A Brief Overview

A factoring company or factor purchases the invoices or accounts receivable from another business. The purchases are made at a price less than the face value of the invoices so that the factoring company can make a profit once it collects the payments that are owed. They generally purchase invoices for services already rendered or goods already shipped to customers with good credit ratings. Typically, these types of companies do not care about any financial troubles that you may have had in the past. It does not matter if your business has bad credit or just went through a bankruptcy. They primarily care about the credit ratings of your customers. You also have to pay the factor a fee for their services. The fee charged depends on the number of customers you have, credit rating of your customers, your average payment cycle, size and age of the average invoice and other variables. Banks have a different set of standards when it comes to funding decisions. Banks make lending decisions based on the financial history, collateral and cash flow of your business. This means that most small to mid-sized businesses with no track record, a weak balance sheet, or a history of financial problems will be refused for loans. These businesses may find factoring to be the solution to their problems. Another difference between factors and banks is the amount of time spent deciding on the funding decisions. Factors may take hours or days to make funding decisions. For banks, it may take weeks or months.

Factoring is not a new financing option. It is a centuries old form of financing. In the past, primarily people who work in the garment or textile industries have used it. All types of businesses that extend credit to their customers use factoring today. Factoring is a $150 billion a year business in the United States.

A factor is a viable option for any business that has cash flow problems. These businesses cannot wait 30 or 60 days for people to pay off their invoices and have immediate financial demands that need to be met. A factor can provide the cash that they need within 24 hours. These businesses can typically get 80 to 90 percent of the agreed upon payment immediately. The balance is held in reserve until the invoices are paid off.

There are two forms of financing offered by factoring companies: recourse and non-recourse. Recourse financing makes the company that sells the invoices responsible for payment if the invoices are not paid off. Non-recourse financing forces the factoring company to take on the risk of non-payment of any invoices. If you go with non-recourse financing, you will get a lower purchase price for your invoices and pay higher service fees.

Factoring companies are more effective in collecting debts than other businesses are because they have more resources that they can allocate to the debt collection process. Factors are only responsible for collecting money that the client is owed. They are not responsible for any situations that involve faulty merchandise or vendor disputes. You should also make sure that the factor is not overly aggressive when it comes to collecting debts. An overly aggressive factor can alienate legitimate customers. In general, factors collect debts in a professional manner. One option that factors offer to debtors is to make one lump sum payment that is slightly less than the total amount of the debt owed.

Michael Russell
Your Independent guide to Factoring