Factoring - Background & History
Factoring is the sale of your account receivables (invoices) to a funding source at a discount off the face value in return for immediate cash. The funding source is known as a factor.
The process typically works like this: You deliver a product or service and issue an invoice to your customer. Without factoring, you wait 30, 60, or even 90+ days for payment. With factoring, the factor immediately purchases the invoice and advances an initial payment of 70% to 95% of the invoiced amount. In most cases, you'll have funds in your account within 24 hours. When your customer pays the invoice (payment is made directly to the factor), you'll receive the remaining balance (5% to 30% of the invoice amount) less the factor's fee.
Factoring is a well-established form of business financing that produces immediate cash payments to a company at the time of shipment, delivery and invoicing a customer. In its basic form, factoring has been used by American business since Colonial times, and its origins go back even further, literally thousands of years to the early days of commerce.
Perhaps the most attractive aspect of contemporary factoring is a continuous level of cash flow into a manager's hands, allowing business planning and operation in a timely and efficient manner. The factoring system also means available financing which automatically adjusts to your unique rate of business growth, because increased cash is triggered by new invoices. Factoring is the only finance mechanism directly linked to a company's sales.
Factoring is used more than all other types of business financing combined. Many of America's major companies are enthusiastic users of this finance system and have been for years. But factoring is not an exclusive prerogative of commercial and industrial giants. In fact, factoring comes a lot closer to you personally than just through big-name business whose products you know and use.
American consumers take part in a common form of factoring every time they use a credit card. There are 1.15 billion credit cards in circulation, 10 each for every American cardholder. In 1970 the average balance on individual cards was $649, increasing in 1986 to $1,472, and today it is over $2,800. Millions of times a day every business that offers customers charge privileges using credit cards is the direct beneficiary of factoring. American retail business depends on the factoring system, and without it the national economy would be seriously handicapped.
In this familiar transaction, the issuing bank or card company is the factor - using the Visa, MasterCard or other system - advancing the seller of merchandise or service cash immediately after your purchase, long before you actually pay. Because the seller gets cash up front without having to wait for your payment, his money is not tied up in receivables. For the double privilege of making credit available to customers and getting immediate payment, the business is willing to pay a discount to the issuing bank or credit card company - typically 2% to 4% of the purchase price. Thus for every $100 of merchandise you buy with a credit card, the seller gets $96 or $98 in immediate cash.
Factoring accomplishes the same for commercial - or business to business - transactions. When you extend credit to a customer, you are essentially becoming that customer's part-time banker. For the period credit is extended to Customer Smith - 30 or 60 days - you become his lender, and he your borrower. For the length of time credit is extended you lose the value of that tied-up money because you can only anticipate payment. If Mr. Smith had paid cash, you could have invested that money immediately, earning interest on it rather than having to wait. When Smith pays late, your cost increases still further.
Since there is no "free lunch" in business, someone has to pay the costs of your extension of credit; either you pay by reduced profits, or your other customers are forced to pay higher prices. In a marginal company, excessive credit extension and late customer receivables can spell disaster.
The point is that once a business extends credit, whatever the terms, it places itself in a cash deficit posture. This is so because the company already expended its available cash for production and service before billing for the delivered finished product.
So, Why Factor?
As a financial management tool, factoring is one of your best options. It does not cost - it saves you money and allows you to make even more. Factoring produces reliable cash flow, reduces your business debt, builds equity, provides customer credit checks and administration, allows company growth, and reduces bad debts. Factoring reduces the stress associated with running a business and allows you to focus on the primary function of your company rather than on cash flow worries and administration tie-ups.
- Offer credit terms to customers. With factoring, you can offer credit terms (or extended credit terms) to your customers without negatively impacting your cash flow. You can grow your business by making it easier for your customers to buy from you.
- Unlimited capital. Factoring is the only source of financing that grows with your sales. As sales increase, more money becomes immediately available to you. This allows you to constantly be able to meet increasing the increasing demands within your industry.
- Take advantage of early payment discounts. Factoring will allow you to take advantage of early payment terms offered by your suppliers. If you can save two percent of your raw materials cost because you have the cash to pay the bills within ten days, then you can use those extra savings towards other areas of your business.
- Invoices are paid faster. Many people don't realize that some debtors pay factored invoices faster than non-factored invoices. The reason is that factors may report payment experiences to Dun & Bradstreet or other credit agencies, and most clients do not. A debtor who is aware of this knows he may impair his credit rating by paying a factor slowly, whereas paying the client slowly may not affect his credit rating at all.
- Credit screening. Our funding sources will provide you with credit information on new customers, which enables you to make better credit decisions. They will also provide ongoing credit monitoring of existing customers to make sure there is no significant diminution in their credit status.
- Factoring helps build credit. Once you begin factoring and you have adequate cash flow, you can begin to pay your bills in a more timely manner and start establishing, or improving, your credit. This improves your chances of getting credit terms from suppliers and improves your chances of getting conventional financing in the future. We can even work with you if you have tax problems or are in bankruptcy.
- Leverage off your customers' credit. A company does not need to be credit worthy to factor. You don't need to be profitable or in business for at least three years or meet any of the other assorted credit criteria required by banks and other commercial lenders. If you have credit-worthy customers, you can get financing through our funding sources.
- Detailed management reports. A funding source provides you with detailed management reports enabling you to better run your business and manage your cash flow. You no longer have to pay someone internally to produce such reports.
- Financial Flexibility. We can work in conjunction with your other lenders if they are not providing you all the money your business needs.
A business must weigh the costs of factoring against not having the immediate cash flow. Most often the choice is between factoring and putting up with severe cash flow problems (and missed sales opportunities!).
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