Business Invoices / Receivables
Factoring:
Factoring
is selling the interest in your receivables or invoices to a factor for immediate
cash. Factoring is an old financial service used by multi-billion dollar corporations
that is now available to smaller sized businesses to which banks are reluctant
to lend funds. Factoring is also called "accounts receivable financing".
A company sells its accounts receivable (invoices) which represents money due
from its customers to a factoring company, at a discount so that it does not
have to wait the normal 30-60 days terms that it takes for the invoices to be
paid. Factoring will help a company stay current with its vendors and other
financial obligations.
The problem with many new and fast growing companies is their ability to obtain
traditional bank financing due to their profitability or financial strength,
and their length of time in business. Factoring will allow new companies to
convert their accounts receivable into immediate cash. Once they have delivered
their product or service, they can get money in less than 24 hours. There are
a number of reasons why factoring can help such a company with staying current
with its vendors and other financial obligations.
Factoring does not have the limitations that are found at most banks. Most types
of financing require two years in business and showing a profit. Factoring
can help young, growing companies who can not obtain other types of financing.
Factoring:
an example of how factoring works.
Smith's Gadget Co. is a growing business, manufacturing
and selling gadgets to other businesses. Mr. Smith generates an average of $100,000
in invoices each month. His customers always pay their bills, but usually in
30 to 60 days. Mr. Smith realized that if he had the cash earlier, he could
take advantage of his supplier's discounts for early payment and discounts for
volume purchases. This would allow him to fulfill orders quicker, increase production
and sales, thus increasing profits.
Mr. Smith decided to sell, to a factor his $100,000 of receivables each month.
Mr. Smith submitted the application and a list of customers that he wanted to
factor. The factor's initial paperwork, including "due diligence",
usually takes 10 -14 days to complete. (His customers' credit was discreetly
checked.)
Upon approval, Mr. Smith submitted invoices to be factored, the factor verified
that Mr. Smith had delivered the goods or services invoiced, and that his customers
are satisfied with the product. Then, within 24 hours, the factor advances $70,000
to $80,000 by wire transfer directly into Mr. Smith's bank account. The factor
then waits for Mr. Smith's customers to pay the invoices.Once the invoices are
paid to the factor, the balance of the $100,000 is paid to Mr. Smith, minus
the fee the factor charges to wait on the invoice payment.
Now that Mr. Smith's Gadget Company is factoring, 70-80% of their invoices are
being paid within 24 hours. Now Mr. Smith is using the accelerated cash flow
to grow his business faster than ever.
Factoring: benefits to the business owner.
While factoring can certainly benefit businesses with cash flow needs, there
are many reasons a business owner should consider factoring.
1. Elimination of bad debt. A non-recourse factor will assume the risk of bad
debt, thus eliminating this expense from the business' income statement.
2. Invoice processing. Factors handle much of the work associated with processing
invoices, including posting invoices to a computer system, depositing checks,
entering payments in the computer and producing regular reports.
3. Offer credit terms to customers. With factoring, businesses can offer credit
terms (or extended credit terms) to their customers without negatively impacting
their cash flow. The business can grow by making it easier for customers to
buy from them.
4. Unlimited capital. Factoring is the only source of financing that grows with
sales. As sales increase, more money becomes immediately available. This allows
the business to constantly be able to meet increasing demand.
5. Take advantage of early payment discounts and volume discounts. If a business
can save 2 - 5% of their raw materials cost because they have the cash to pay
within ten days, this significantly reduces the true cost of factoring. Coupled
with the ability to make volume purchase with the cash advances, they will likely
save even more money.
6. Stop offering early payment discounts to customers. Since companies that
factor receive their money immediately, they don't need to offer early payment
discounts. Factoring will save every dollar in discounts that customers were
taking. By realizing this savings and taking advantage of the early payment
and volume purchase discounts, the business owner may be able to offset the
cost of factoring.
7. Don't give up equity. The business owner does not have to give up any equity
in the company (as is usually required with venture capital) or take on any
partners, with factoring.
8. Don't incur additional any debt. Factoring is not a loan and therefore the
business is not incurring any additional debt.
9. Detailed management reports. The factor provides detailed management reports
allowing for better management of cash flow.
10. No geographical limits. A factor can work with a client in any part of the
country and that client can have customers all over the world.