Invoice factoring of receivables is a process where a company sells its accounts receivables to another company, such as banks. These types of institutions specialize in buying them and has the resources to service this need. This is a popular method for short-term financing. Factoring has many benefits, including:
- Better source of financing
- Resources to sellers and manufacturers for collection book debts
- Saves time required for debt collection
Factoring institutions provide important functions, including:
- Credit administration including the collection of debts
- Credit financing where the factor lends money against receivables
- Credit recording involving debtor’s ledgers
- Expert advice to customers about finance and business information
The entire process is basically a three party system with the seller, debtor and factor involved.
When the seller is owed money by the debtor it is called accounts receivable. The seller sells the invoices to the factor at a discount for quick advancement in resources (aka cash). Once the debtor pays the full amount back to the seller for full price a profit is made.
The two types of factoring loans are recourse factoring and non-recourse factoring and both can provide quick funding. Recourse requires that you pay for funds not collected by the factor and the factor then charges you a cheaper rate for the accounts receivable services.
Non-recourse is where the factor assumes all risk if they ar unable to collect your unpaid sums. This can be more expense but more reliable at the same time.
Why Factor Loans?
Often times business cash flow hits a dead period for one reason or another. Perhaps your business is seasonal and you’ve miss-appropriated funds and need an advance for the busy season.
Sometimes customers bay up to 120 days after being invoiced, crippling your business.
So to help out a business may find the the factor option to be a good one despite a slight discount. A company wanting to grow aggressively may take this route.
Research is the best approach when deciding how to progress with factoring. Be sure to speak with a person in person or on the phone that contacts you and ask questions. Find out about their experience and get a feel for their professional manner. These people will deal with your clients to get the money so you want to make sure they represent you properly. If the factor is unprofessional it will reflect poorly on your business, even if the service is outsourced so keep that in mind. If your clients have a good experience they will be more likely to come back. Figure out their process and the paperwork involved so you can sort of feel the client experience.
Be sure to ask if the will be able to collect fewer invoices in larger amounts. This can save lots of time on your end, thus making the service ‘worth it’.
Questions to Ask When Outsourcing Invoice Factoring
When you are near the decision making part of your invoice factoring process, there are a few additional questions you will need to ask your chosen factor. One question to ask that will end up saving you time and money is whether or not your factor will be able to accept fewer invoices with larger amounts. Choosing to go this route will save your factoring business more time in the long run and save you in fees charged. Another question to ask during the factorization process to save you money is in regards to negotiating for more money up front. Factors may allow for a larger sum in the beginning of the accounts receivable financing process, in exchange for a higher discount rate.
Read more about how to choose a factoring company from our Buyer Guide and by conducting your own preliminary research.
If you have slow paying clients, ask the factor how they go about collecting sums and the duration of the time they allow for each client to take to pay off their invoices. Factoring loans can be a great way to feed extra money into your company, but make sure to decide on the most qualified factor for the job and review costs associated with it beforehand.
Business Factoring – The Guide Index
