How It Works

Most business managers are not experienced with factoring, accounts receivable, or contract/purchase order financing. The truth is they really are. In fact one only needs to think of credit cards and how that process works to understand the underlying fundemental of factoring. Credit card companies provide immediate cash for a sale and assume the credit risk for the customer. The business recieves the funds from the sale minus a merchant fee (the same principal in factoring) almost immediately and then the credit card company collects the funds from the business' customers. This is similiar to non-recourse factoring.

Factoring Example:

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.

Benefits of Factoring

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.

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