What is factoring?
Factoring involves the sale of accounts receivable (invoices) to a factoring company by a business owner. The sale is accomplished through a transaction called an assignment. Depending on the creditworthiness of the end-payer (the one who has to pay the invoice on the due date), the invoice is classified as either approved or non-approved. A factor will provide its clients advances (loans) against these accounts receivable. The advance rate is pre-determined at the time of opening an account at a factor. The factor usually carries out the collection of invoices that it has purchased.
What is a factor guarantee?
The easiest way to understand factoring is to think of it as a Visa or MasterCard for the business. When a retail customer makes a purchase and presents his credit card, the merchant transmits the information to the credit card company and requests a credit approval for the amount of the transaction. If the amount is within the purchaser's credit limit, the credit card company provides the merchant with an approval number and agrees to accept the risk in case the purchaser is financially unable to pay. When a factor approves a customer and issues a payment guarantee, the related invoices are called approved or non-recourse accounts.
How do you determine if an account is approved?
Payment history, outstanding past dues, and current financial information determine a customer's credit standing. After evaluating these criteria, the factor will make a credit decision on the order. When a factor approves an order, it gives an approval number in writing. If the factor cannot approve an order, it declines it.
What is an advance?
When a factor purchases invoices from a client, the client can borrow up to a certain percentage of the invoice amount from the factor. This borrowing is called an advance. Approved orders are usually eligible for advances of up to 80% of the invoice amount, while non-approved orders may be eligible for advances of up to 60%.
How long does it take before I can receive my advance?
To expedite funding, a client must submit a complete set of documents to the factor: invoices, shipping documents, purchase orders, and assignment sheets. Upon receipt and successful processing of the documents, the factor can provide a check or wire within 24 hours of the assignment.
Why do companies sell their receivables?
Companies that are growing often cannot afford to have cash tied up in receivables for 30 to 60 days. Through factoring, companies can quickly convert their accounts receivable to cash in order to meet their immediate financial demands.
Which industries are best for factoring?
Factoring is not limited to a specific industry. Any company that sells products or provides services on terms is a candidate for factoring. Companies that receive payments by cash, credit card or C.O.D. (Cash On Delivery) do not require factoring.
I do not want to use advances. Can I still use factoring services for payment guarantee and collection?
Yes. Factors provide payment guarantees and collection services for non-recourse accounts. While recourse accounts are not eligible for payment guarantees, factors will make the same effort to ensure prompt collections.
How can I afford to use a factor when my profit margin is very low?
All companies, especially those with small profit margins, should weigh the costs and benefits of factoring carefully. The key issue is whether a company can increase its sales and net profits by working with a factor. Overhead costs do not necessarily increase in proportion to sales. An increase in sales realized through factoring can result in higher net income.
My invoices are pledged as collateral on a bank loan. Can I still use a factor?
Banks generally will restrict advancing against the invoices when they possess priority in collateral. These clients can use only the guarantee service of a factoring company to protect their receivables. On rare occasions, banks may allow clients to use both guarantee and advance services. Such arrangements must be negotiated with the bank prior to signing with a factor.
Can an individual receive the services of a factor?
No. Factoring is catered to the needs of businesses. However, individuals who operate their businesses as a sole proprietorship are eligible for factoring.
Why not just go to a bank?
A bank may be an alternative. However, you should consider the following: Banks' credit criteria are often more stringent than those of factors The loan process may take too much time Banks require financial statements that reflect 2 to 3 years of profitable operation and positive cash flow As sales revenue increases, banks may not increase your loan timely to meet your growing demands