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 factoring loans, 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.

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 and accounts receivable financing has gotten a bad rap. A lot of the myths about invoice factoring simply aren’t true — for example, the myth 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:

Financial statements, management reports, and forecasts

It is important to generate accurate and timely financial statements, as well as for the owner to know exactly where the business is financially at all times — and where it’s headed. By accurately tracking factoring fees, the business is better able to build up and earn back those fees. Value will be gained via an increase in gross sales, discounts for paying vendors early, and overhead reduction. Factoring will look expensive unless it is properly measured against the value it brings.

The factoring contract

Be sure that you understand all details in any contract you sign with a factor, as well as the fees you will be charged. Beware of factors who issue a term sheet without doing proper due diligence. What may appear to be a low factoring rate at the outset could end up being very expensive when things like lockbox, minimum usage, credit checking, and wire transfer fees are included.

Monitoring of factoring facility and working capital

Make sure that a senior financial person on your staff has sufficient time to monitor usage of the factoring facility and working capital-oriented items. By borrowing only what you absolutely need, you will be able to minimize your factoring expense. It’s also important to monitor the aging reports and become involved if any trade or payment disputes arise.

Maximum efficiency

Increasing efficiencies in your backroom operation can have significant positive implications on your bottom line. By understanding all the services that your factor performs, you will be able to better utilize your staff and your own time. Understanding the reports and implementing controls and procedures will minimize errors and increase efficiency.

Open communication

It’s important to have a clear channel of communication with your factor. You might be surprised at the flexibility your factor (and others) will provide when you are open and honest with them. It’s also important that you communicate directly with the factor if you are aware of any issues or problems with your invoicing or customers. A good factor can deal with most issues if aware of them — but like most lenders, factors don’t like to be surprised.

Pick Your Partner Carefully

Since a factor will become an integral part of your business team, it’s important to select your partner carefully. Professional experience and adequate capitalization are especially crucial. Don’t be fooled by Internet claims of very low rates and a “24 hour application process.” Good factors are as choosy about their clients as you should be about your financial partner. When everyone performs their proper due diligence, you are more likely to build a foundation for a positive relationship for many years to come.

Ready For Your Bridge to Bankability?

Why Choose The Commercial Finance Group For Invoice Factoring

If you are considering invoice finance as an option for improving your company’s cash flow, we look forward to assisting you. While there are many invoice factoring companies to choose from, we believe you will truly benefit from choosing to work with our team. Here at the Commercial Finance Group, we have decades of experience assisting small businesses in selling accounts receivable. We understand the intricate details of what accounts receivable funding will mean for your company and how to best utilize it for furthered growth. When you choose to work with our team, you will benefit from this extensive industry knowledge and you will have the freedom to ask us any questions you want in order to understand exactly how factoring services work.

Not only do we have a deep knowledge of how this unique funding solution works, but we also treat every single client with respect and we take the time to get to know their company before suggesting any funding solutions. If we think that accounts receivable funding is the right option for your business, we will let you know why and how it can benefit you specifically. If, however, we think there are better solutions for your business, we will let you know that as well. We want to ensure that you are paired with the ideal funding solution for your company that will contribute to long-term growth. We know how hard it can be to decide upon the right solution for your company and we recognize the dedication you have to your small business. If you have been searching for the best factoring companies around, we invite you to reach out and talk to our team to see if we are the right fit for your needs.