Factoring is a financial product that allows companies to sell their uncollected invoices (accounts receivable) to a financial institution, also called an element.
Factoring companies or factors as business factors purchase invoices for a percentage of their total value. They then are responsible, in some cases, for collecting invoice payments from the debtor company.
Factoring is an increasingly popular form of alternative business financing. This type of alternative financing has grown in popularity since it has become more difficult for companies to access traditional bank financial products. It is effortless to operate.
Most factoring companies pay in two installments, the first covering most of the accounts receivable (which satisfies the company’s need for instant cash flow) and the rest when the client settles the invoice, minus the cost of the factoring service.
The necessary steps of the operation are as follows:
- The company sends details of its invoices to determine if it is eligible for a factoring contract.
- Then, the factoring company will evaluate how risky the loan is (this is industry-specific, as well as the customers who owe the company) and then give you a quote.
- Once an agreement has been reached, the factor will provide the company with the cash.
- The element will then start collecting the bill from its customers.
- Once the account has been collected, the element will pay the company the remaining balance of its money, minus the factoring service’s cost.
When a company has accounts receivable, it may take weeks or even months to see some of that money, but if someone buys those accounts receivable, they can give you cash for your invoices right away, so you can use it to pay the payroll, pay your bills or attract new customers.
Bills that are on time for payment generate a smaller discount than older statements and delinquent accounts. It will probably be difficult for the factoring company to accept funds that are more than 90 days past their due dates.
Factoring transactions can be with or without recourse. In a recourse factoring transaction, the company selling its receivables must repay the advance and fees if the customer does not cancel the invoice by the recourse date, usually 90 days after the invoice date.
In a non-recourse transaction, the factor assumes the risk of non-payment. In this sense, conditions with or without recourse refer to the risk of bankruptcy or insolvency of the customer and do not apply to commercial disputes or returned goods. It should be noted that in a non-recourse transaction, the factor can examine the customers’ credit in more detail before committing to purchase the accounts.
Advantages
A fast and secure cash flow source by financing accounts receivable and releasing working capital tied up in uncollected invoices.
You can reduce the time spent on administration and collection of overdue payments, as the factor takes responsibility for collecting the debt and taking over the management of your credit control.
Factoring is less expensive than using capital investors.
As experienced debt collectors, professional factoring companies can improve customers’ payment times.
Invoice financing can better control cash flow, where there may be different credit conditions among your customers.
Invoice financing is ideal for new businesses, entrepreneurs, and even companies with bad credit; to obtain funding more effectively, approach business factors’ experts.