When I tell people that I am the portfolio manager of a factoring company I typically get the same response.
What is factoring???
At its most basic level, the definition of factoring is very simple.
A factoring company (or “factor”) purchases a business’ invoices and provides immediate funding to that business. Subsequently, the business’ customers remit payment for those invoices directly to the factoring company.
It is important to note that when people refer to factoring, there are several terms that are used interchangeably but all refer to the same process.
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Invoice factoring
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Invoice financing
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Accounts receivable factoring
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Accounts receivable financing
Although factoring has been a common form of business financing for hundreds of years, the concept of factoring is largely an unknown and misunderstood form of commercial financing.
Historically, factoring tended to be very common in certain industries such as the textile and garment industry, furniture manufacturing and transportation industries where there are typically longer payment terms.
Today, factoring is becoming increasingly more popular and widespread, particularly with small businesses that are unable to qualify for traditional financing. Factoring companies are focused more on the creditworthiness of their client’s customers. As a result, a company that does not qualify for a traditional bank loan may still be able to factor their accounts receivable.
Here is a brief example of a factoring transaction.
The parties involved in factoring:
1. ABC Company – seller of the receivables or invoices (the “seller”)
2. 123 Customer – the customer of the seller (the “debtor”)
3. Factoring Company – the company that purchases the invoice from the seller (the “factor”)
General steps in a factoring transaction:
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ABC Company receives an order for goods or services from 123 Customer and ABC Company performs the services or ships the goods to 123 Customer.
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ABC Company sells the invoice to their Factoring Company and the ownership of the receivable has now been transferred to the factor.
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Factoring Company sends the invoice to 123 Customer (on behalf of ABC Company) and obtains the right to receive payment from 123 Customer.
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The Factoring Company immediately advances funds to ABC Company at a specified percentage of the face value of the invoice (typically, this amount is between 75% and 85% of the total invoice amount).
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The remaining amount between the face value of the invoice and the initial advance amount is referred to as a “reserve” and is held by the factor until payment is received from the debtor.
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123 Customer remits payment directly to the Factoring Company.
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Factoring Company then remits the “reserve” less the factoring fees to ABC Company.
The benefits to ABC Company:
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ABC Company was able to increase its cash flow immediately without waiting 30 to 90 days to get paid by 123 Customer.
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ABC Company’s improved cash flow position will allow the company to fill that next large order, meet payroll or obtain new business.
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ABC Company can take advantage of services that factors, unlike banks, provide. Services such as:
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Assisting their clients with credit checks on customers
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Monitoring accounts receivables
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Assisting in collection efforts when necessary
If you are a small business where your accounts receivable is one of your largest assets and have a strong, creditworthy customer base, but you’re having to wait 30, 60 or even 90 days to get paid, factoring can have a tremendous impact on cash flow by providing immediate funding to support your business.
Learn more about factoring and Fast A/R Funding’s services by downloading our informative “Factoring 101” guide, or call 888.833.2286 to speak with one of our small business finance consultants.