Factoring is a financial method that companies can use to increase the available money in their cash flow.
It is a method that many people are unfamiliar with, but it can benefit a company that is not able to acquire a business loan or equity for their company.
Business funding can be hard to obtain these days, and if a lender does not think a business has "high-potential"-- or if the company has bad credit or no credit--it can be incredibly difficult to get funding in more traditional ways.
Factoring is sometimes seen as a last resort type of financing, however this is not completely true.
For any business owner who cannot obtain a business loan, equity, or some other type of funding, factoring is just one of the methods that can help them get money fast.
It is most applicable for businesses that sell products, supplies, or services for a fee.
This is because factoring, also known as accounts receivable financing, is when a company sells unpaid invoices from its buyers to an entity known as a factor.
Who and what is involved in factoring? The Seller You and your business are the seller.
You sell accounts receivable invoices to financial institutions at a discount.
Receivables These are the invoices, or accounts receivables, that the your business can sell.
The Debtor Debtors are individuals who owe you money.
They are the individuals whose invoices you sell.
The Factor A factor is a financial institution that will buy unclosed accounts, or invoices, from a seller.
What is the process of factoring? --> The seller choices invoices to sell at a discount to a factor.
--> The factor buys the invoices and then attempts to collect the money owed on the invoice from the debtor.
--> The debtor pays or does not pay the factor.
Need To Know...
+ Most factors charge a service fee.
+ Some factors also charge interests based on how long it takes for the debtor to pay them.
+ Along with the discount amount that the factor pays, there may also be a "reserve.
" A reserve is a second agreed upon amount of money that the seller receives if the debt is paid in full.
+ Since there is always risk involved for the factor, invoices are always sold at a discount (less than the actual invoice amount).
+ Factoring works best for companies who have low cash balances to work with, and who have many invoices which their customers have not paid.
+ It is a good idea to only sell invoices that will allow you to at least break even on the sale with the factor.
The seller determines which invoices they can sell to a factor.
Some times there is little "room" between what the seller will receive from the factor and the actual amount of the invoice.
All invoices are sold at a discount, never at their actual worth (which is equivalent to what the debtor owes).
This is because there is always the risk that the debtor will not pay the factor, and because once the invoice is sold the factor takes on responsibility for the account.
Benefits of Factoring + Your credit does not come into play.
The factor only looks at the credit worthiness of your debtors.
Many factors will only buy invoices for debtors with solid credit because there is a much higher chance that they will be paid.
+ This financial method gives businesses time to get out of financially constraining periods.
+ It is also a type of "bridge financing" because it allows the company to create cash flow while awaiting a loan or other form of funding.
+ It is a quick and easy way to obtain money in the short-term.
+ Factoring can be combined with other financing methods to further help increase a company's cash balance.
Recourse Vs.
Non-Recourse Factoring Non-recourse factoring is when the factor takes on full liability for the invoice they bought.
If they do not get paid, you are not affected in any way.
You will not owe any money, etc.
Recourse factoring is a little more complicated.
In short, it means that you will bear some liability and will have to pay an amount of money to the factor if the debtor does not pay.
This financial means of obtaining cash is complex and there are many different elements, risks, payment terms, rewards, and more involved.
It is always best to consult with your accountant before proceeding with factoring.
Factoring is also an option for established companies.