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Using Factoring to your Advantage
Factoring involves selling your outstanding accounts receivables at a discount to a factoring company. It is an alternate source of financing that does have both positive and negative aspects to consider depending on the nature of your business. The influx of immediate cash is one of the high points. It being one of the more expensive forms of financing is one of the pitfalls.
During the process of factoring, your business will sell its receivables to the factoring company at a lower cost. Once your business has figured the number expected to receive from its customers, the right to collect is transferred to the factoring company. The customers are alerted of the amount owed and that the price is to be paid to the alternate company. The amount of money expected from your customers is now to be paid to the factoring company (all fees and responsibilities of collection are now theirs), and in return, the factoring company immediately gives you the money expected from the customer at a discounted rate.
"Profit is the result of risks wisely selected."
Get Most Now and a Little LaterAdvance and reserve types of factoring are most prevalent in small businesses. The business will sell rights to their receivables for about 60 to 80% of the face value. The selling company will get immediate cash up front from the factoring company, with the remaining balance serving as reserve. The factoring company now takes the responsibility of collections, and when the customers pay, the reserved money is released (the factoring company deducting its fee- about 1 to 5%), and pays you the balance.
The Legitimacy of the Discount FeeThe 1 to 5% that the factoring company takes as their payment is called the discount fee. The factoring company is not so interested in the company in which they are receiving as they are in that business customers ability to pay the amount owed. The nature of the intended receivables is really what dictates what the discount rate will be. Discount rates will vary with each factoring company and the age of the receivables. The discount rate will be lower if the age of receivables is relatively current and will increase the older the debt of the customers is. Delinquent accounts exceeding ninety days will be more expensive and difficult to factor.
Choosing a Course of Recourse or Non-RecourseFactoring transactions can be labeled as either recourse or non-recourse. A recourse transaction involves the selling company repaying the advance it received along with the factor fees if the customers do not pay what they owe by a specified recourse date (which is usually ninety days after the invoice). The nature of non-recourse transactions involves the factoring company assuming the risk of delinquent payment. The two types refer to the risk of bankruptcy and insolvency by the customer and not to aspects such as trade disputes or returned merchandise. A factoring company will more closely analyze their risk involved by looking at the credit of the customers involved during a non-recourse transaction.
The Satisfaction of Factoring
There are ups and downs to the decision to decide if factoring is right for your business. Here are some of the finer points to consider.
"In the state of nature profit is the measure of right."
- The factoring company is more interested in the customers ability to pay and not so much on your business, so your businesss credit rating is not so much of a factor. This is advantageous for businesses just starting up who will pay more or not get granted access to more traditional financing such as bank loans.
- Only receivables are considered as collateral (in recourse deals; under non-recourse there is really no collateral). Your business can use other assets to borrow money at this time.
- There is basically no long-term commitment with the factoring company, so it can be a flexible form of financing. If your company chooses to do so, you can continue to factor out invoices again and again to the same company.
- The factoring company adopts the responsibility of collection, so these would be resources can be channeled differently by your business. If the factoring is done effectively, your business will be saving money on administrative functioning.
- If your company is amidst a period of rapid growth, having access to the immediate cash from the factoring company will serve you well. If you had to wait a period of thirty, sixty, ninety days, or longer to collect from your customers, this could stymie your opportunities for expansion.
- Since factoring your receivables will make your company immediately look like it is in a stronger cash position, this will make it easier to seek more traditional financing opportunities.
- Factoring your receivables is using your own resources to finance operations, so this eliminates possible debt or having to raise more equity.
- Factoring will help your businesss credit rating by having the ability to pay cash to meet payment due dates.
The Flaws of Factoring
As the adage goes, you must take the good with the bad, and factoring is no different. Though there are many advantages to factoring, there are also disadvantages to ponder upon as well.
"The engine that drives Enterprise is not Thrift, but Profit."
Analyzing the AspectsConsider your companys immediate cash flow and other options open such as bank loans for financing. Your amount of working capital tied to accounts receivable will influence your decision. Remember that the credit-worthiness of your customers will have an impact on the advance and discount rates coming from the factoring company. If your business usually experiences a significant time lapse between purchase and final collection from customers, then factoring will be more appealing to you. Periods of inception and rapid growth will be good times for you to consider factoring. The aspect of receiving immediate cash can serve monumentally if your company cannot acquire other loans or needs the money quickly.
Your Type of BusinessFactoring can be advantageous to a business experiencing difficulties with liquidity and needs cash to meet obligations. Factoring will enable you to get through rough times without attracting any additional debt and adversely affecting your credit rating. If your business is already in debt, factoring can be a way of finding the immediate money needed to get out of it without incurring more debt from an outside provider. If your business is in credit trouble, the factoring company will bypass this fact because they are more concerned with your customers credit.
The Help of Doing HomeworkWhile doing business, you want to surround yourself with reputable partners. It is always safe to do your homework researching companies with a good name and past. Consulting an advisor or consultant is a good decision. Compare different quoted discount rates from several factoring companies and make sure all terms and conditions are clearly outlined upon the beginning of the business relationship.
DocumentationThe application for getting started is virtually painless. Make sure that your receivables are accurately documented, supported by the invoices factored, and either your product or service delivered to the consumer before starting the process of factoring. You will need most recent account receivable aging reports, sample invoices, and most recent financial statements. The factoring companies charge one-time fees once the proposal is agreed upon to cover administrative costs, filing fees, and other ancillary expenses.