Factoring, receivables factoring or debtor financing, is when a company buys another company’s account receivables (invoices). Essentially factoring transfers the ownership of accounts to another party that then chases up the debt. Factoring is one of the oldest forms of business financing, and is the cash-management tool of choice for many companies especially where long receivables are part of the business cycle.
This form of financing helps businesses with cash flow problems due to slow-paying customers. By financing its invoices, the company with cash flow problems has working capital, while the buyer, or factor, chases up the debt for the full amount and profits when it is paid. Companies choose factoring if they want to receive cash quickly rather than waiting for the duration of the credit terms. Basically the factors extend credit not to their clients but to their clients’ customers, and are more concerned about the customers’ ability to pay than the client’s financial status. That means a company with creditworthy customers may be able to factor even if it can’t qualify for a loan.
Factoring is not a loan; it does not create a liability on the balance sheet or encumber assets. It is the sale of an asset–in this case, the invoice. And while factoring is considered one of the most expensive forms of financing, that’s not always true. Yes, when you compare the discount rate factors charge against the interest rate banks charge, factoring costs more. But if you can’t qualify for a loan, it doesn’t matter what the interest rate is. Factors also provide services banks do not: They typically take over a significant portion of the accounting work for their clients, help with credit checks, and generate financial reports to let you know where you stand.
Factoring is a short-term solution; most companies factor for two years or less. Plant says the factor’s role is to help clients make the transition to traditional financing. Factors are listed in the telephone directory and often advertise in industry trade publications. Your banker may be able to refer you to a factor. Shop around for someone who understands your industry, can customize a service package for you, and has the financial resources you need.
Types of invoice factoring
There are two types of factoring products: full recourse and non-recourse solutions. Unfortunately, there is a lot of confusion among clients regarding these two options.
Full recourse factoring: In a full recourse plan, the factor has the option to sell an invoice back to you if it’s not paid after 90 days.
Non-recourse factoring: In a non-recourse plan, the factor cannot sell the invoice back to you if it’s not paid after 90 days, as long as the reason for non-payment is a credit problem. This last point often causes confusion. Many factoring companies define a credit problem as a declared bankruptcy. However, this definition varies by factor. Learn more about the pros and cons of non-recourse factoring.
The better plan is actually a matter of personal choice. In the past, there were substantial differences in pricing between plans. This is no longer the case. Also, recourse plans can be a bit more flexible than non-recourse plans.
Contact Greenback Capital about our Factoring services.
