What is Factoring?
Factoring is a form of financing where a business sells its accounts receivable to a funding source/financier known as a factor. Once a business sells its accounts receivable, or invoices, the business immediately receives cash for a percentage (usually 70-80%) of the invoice. The remainder, less the financier's fee, is paid to the seller when the full invoice payment is received and cleared by the factor.
The following example shows how simple factoring really is:
Consider a software development company who has just delivered $100,000 of software to a major computer manufacturer. Instead of waiting the typical payment period, which could be 90 days or more, the software company could factor the invoices and receive between $70,000 and $80,000 within 24 hours. This cash could then be used to fund a marketing campaign for a new software release, or simply pay off some outstanding debt. As soon as the computer manufacturer remits payment, and the payment is cleared, the software company will receive the remaining value of the invoice minus the factor's fee. Historically, fees average about 5% to 6% of the original invoice amount. This means the software company could recover up to 95% of the original invoice. (Naturally, the specific circumstances of the client dictate whether the fee is higher or lower).
FACTORING TYPES AND PROGRAMS
To be sure, in an industry as broad and diverse as that of factoring, there are virtually as many program types and conditions as there are factors. Universally, however, factoring can be divided into two broad categories.
(Compare Factoring to other forms of Financing and see why it may be your best choice)
Maturity factoring or Old Line Traditional factoring is a non-recourse transactional relationship in which the factor collects payments from account debtors, handles the tasks of bookkeeping and accounting, and assumes the risks of bad debt from bankruptcy and non-payment.
Although deviations do exist, maturity factors do not advance money to the client initially but are responsible for seeing that customers pay invoice balances promptly. The factor’s fees are based on the average collection experience of every customer. In the event that the customer does not pay in the allotted, average time, say 45 days, the factor immediately pays the client and proceeds to later collect from the customer.
Since the factor only advances on those invoices not paid in normal terms, fees for maturity factoring are generally quite modest, usually …1% to 2% of the face value of the invoice. Traditional maturity factoring is virtually always non-recourse and addresses the problems of credit and collection. It allows the client to establish a predictable cash flow and insure payments at a very modest cost.
Upon request, maturity factors will pre-pay their obligation, thus creating an advance. Since the maturity factor has already agreed to pay the invoice based on average collection experience, an advance is viewed as simply an early payment of the factor’s obligation. Additional factoring fees for the earlier payment will be charged accordingly.
By far the most widely used, advance/reserve factoring transactions immediately advance cash to a business at the time of invoicing or immediately upon the shipment of goods. Unlike maturity factoring where the client expects to wait 30-60 days prior to being paid, advance factors tend to put their clients on virtually a C.O.D. basis with account debtors.
Because such advanced funds are outstanding for a significantly longer period of time, advance factoring is slightly more expensive than maturity factoring. Rate structures will vary dramatically between factoring firms and will be influenced by the average size of invoices to be purchased, monthly volumes, industry risks, and the creditworthiness of the customers among other things.
Typically, clients should be prepared to pay between 4% and 8% for customer payments received by the factor with 60 days. Advance factoring my be recourse or non-recourse and will primarily address the problems of cash flow and working capital rather than issues of credit and collection, which will become concerns of a secondary nature.
According to a recent poll completed by the Edwards Research Group of Newton, MA. , only about 20% of domestic factoring firms offer maturity factoring programs while virtually all offer some form of advance factoring. By far, the vast majority of factoring clients require the immediate injections of working capital that advance factoring provides.
The Five easy steps to how it works
A simple application, a copy of your Articles of Incorporation, aging report and a sample invoice is all that's required to get started. The factor buys the qualified receivables you want to sell, advances the agreed upon amount and deposits the amount into your business checking account, generally within 24 hours. You, along with the factor, notify your customer of the new payment address. The factor will send invoices to your customers, collect and process their payments - all at no additional cost. Most factors will provide you with daily, weekly, and monthly statements of activity on the accounts.
If your tight cash flow is preventing you from accepting new business or even threatening your very existence, get in touch with $ilver $tate Funding today!
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