In today’s business climate, using alternate financing such as Invoice Factoring is an accepted method of maintaining stability within a company. Simply put, factoring is a financial transaction between a company requiring accelerated payment on invoiced goods or services – and a financial lender buys the accounts receivable at a discount. By selling its accounts receivable invoices to an alternate financing lender (or a ‘Factor’), the company receives immediate access to a cash advance based on the value of the transferred invoices. The Factor then collects payment on the invoices directly from the company’s customers.
Factoring companies finance invoices by purchasing them. Using your invoices as collateral, the finance company advances funds to your company – providing you the resources to pay important expenses. The invoice is financed in two instalments: the advance and the rebate. Most transactions follow this format:
- You submit the invoice to the Factoring company,
- Factoring company deposits the advance to your bank account,
- Your client pays the invoice after 30 – 90 days,
- Factoring company rebates you the remaining funds, less a small fee.
This financing strategy works well with-
- startup operations,
- high growth companies with insufficient working capital,
- businesses in transition: – companies that have tripped their bank covenants,
- companies experiencing a tough year, or companies going through a change of ownership,
- companies who can not acquire the funds they need from traditional lenders.
The ability to turn accounts receivable (A/R) into cash without having to wait 30 to 90 days for payment enables a business to operate in a more stable and predictable manner. Factoring is not a loan, and no business or personal collateral is typically required to secure the amount of funds forwarded.
The main advantage that factoring provides for a business is easy access to a predictable stream of cash that matches sales output no matter how long customers take to pay. Utilizing factoring, a business has the available capital to purchase materials as needed based on client demand and also the ability to pay infrastructure costs in a timely manner.
The cash advance rates are based on a variety of elements, such as; type of industry, client credit scores, business volume, and programs selected. Different programs are available and will be customized to your company’s specific needs and goals.
Factoring vs. bank financing: Since factoring is not a loan, the company does not assume debt or have to pay interest. The amount of financing matches the company’s A/R, therefore there is no set limit on the funds available. A company does not necessarily need to provide financial, asset, and liability reviews to qualify for factoring transactions. Applying for factoring takes a few days, not weeks or months.
Bank Loan: Qualification is based on the financial performance of your company and your personal credit history.
Factoring: Qualification is based largely on the creditworthiness of your customers.
Bank Loan: Bank loans usually require hard assets to secure their loan such as a building, equipment or personal assets like your home.
Factoring: Your receivables become the security; no other hard assets are required.
Bank Loan: Banks often take weeks, even months to approve a loan.
Factoring: Accounts are typically approved within days of receiving an application.
Bank Loan: A bank usually requires restrictive covenants to govern the terms of the loan such as restricting the amount of debt a company can take on to buy equipment. This often restricts the growth of a company and ties the hands of the owners.
Factoring: No restrictive covenants exist in a factoring agreement providing maximum control and flexibility to the owner.
Bank Loan: Bank loans require regularly scheduled payments of principle and interest.
Factoring: Factoring fees are deducted from the transaction making the cost of factoring simple, easy to manage and affordable.
Bank Loan: You are responsible for the ongoing collection and management of your receivables.
Factoring: Professional Account Managers monitor and collect on your behalf, removing the headache of managing your receivables.
It is worth mentioning that there is usually a requirement that the invoiced clients show a satisfactory credit history based on a review of your company’s payment records. Also, your customers will know that you are using this type of financing as they receive a Notice of Assignment advising them of your factoring relationship. It is recommended that you advise customers that invoices will be verified regularly as part of the quality assurance process, because every so often, the verification process uncovers a problem. Often, problems occur if your client is not satisfied with the services or if there is a misunderstanding regarding expectations. Most factors inform you of issues immediately so that you can engage your customer and resolve the problem. Invoices that have disputes normally can’t be financed until the problem is resolved.