What is Factoring?
Factoring is a financing method where an owner of a business sells accounts receivable for a discount to a 3rd-party funding resource in order to raise capital.
Amongst the oldest types of financing, factoring includes the most selected cash-management tool for most companies. Factoring is extremely common in specific industries, like the clothing industry, in which long receivables include a portion of the cycle of business.
Within a usual factoring arrangement, a client will make a sale, deliver the service or product and generate an invoice. The factor (funding source) purchases the right to collect an invoice by concurring to pay out the invoice’s face value less the discount–usually 2% – 6%. A factor will immediately pay 75 – 80% of the face value and forward the rest (less discount) as the customer pays.
Because a factor extends credit not to a client yet to the clients’ customers, it is more concerned with a customers’ capability of paying than a client’s financial status. This means a business that has creditworthy customers might have the ability to factor even if it cannot qualify for a loan.
As used mainly by large companies, factoring is now becoming more widespread and the best factoring companies provide their services successfully in the market. Plenty of misperceptions in regard to factoring still remain.
Factoring isn’t a loan; it doesn’t create a liability upon the balance sheet or encumber any assets. It’s the sale of an asset–in this instance, the invoice. And as factoring is thought to be amongst the costliest types of financing, that isn’t always a fact. Yes, as you compare discount rate factors charge against interest rates that banks charge, factoring will cost more. However, if you cannot qualify for a loan, it does not matter what your interest rate is. Also, factors offer services that banks don’t: They usually take over a substantial part of the accounting work for their customers, assist with credit checks, as well as produce financial reports to allow you to know where you stand.
Factoring includes a short-run solution; the majority of corporation’s factor for 2 years or less. A factor’s role includes helping customers make a transition to traditional financing. Factors will be listed inside the telephone directory and oftentimes advertise within industry trade publications. A banker might have the ability to refer you to a factor. You can shop around for somebody who has an understanding of your industry, is able to tailor a package of services for you, and possesses the necessary financial resources.