Factoring is a transaction in which a business sells its accounts receivables, or invoices, to a third party commercial financial company, also known as a factor. Factoring is sometimes called accounts receivable financing. Businesses turn to factoring because they may be unbreakable or they do not qualify for a traditional line of credit. This option becomes their alternative and they can receive cash more quickly than waiting 30 to 60 days to receive customer payment.
When a business first begins the process, there’s a fee charged for audit and set-up of the account.
Once set-up, the Factor will advance funds immediately at the rate of 80% of current receivables under 60 days, usually by the next business day after approval. Each transaction made has a fee associated and an interest rate for the funds advanced, usually 16-18%.
Soon the company loses control over the collections of A/R, as the factor does all collections in a very strict and ridged process with the customer remitting funds directly to them.
Once a receivable goes over 60 days the Factor will deduct that receivable from any remittances due and there is, yet again, a fee for this.
During the course of the relationship, when the Factor collects from your customers, the factor will pay you the reserve balances of the invoices, minus a fee for assuming the collection risk. However, if a receivable goes bad the Factor will, of course, charge you a fee.
All fees for factoring, both disclosed and hidden, can add up to as much as 21%.
Factoring fluctuates with your company revenue. If your company is doing well it can grow rapidly with you but if your company is not it will contract just as quickly. Factoring may not be a good solution for businesses if you change based on seasonality or have other significant downward fluctuations in revenue.
To avoid all of the compounding fees of Factoring, a relatively new product, called the SBA CAP Line, has now emerged. This is the least costly means of borrowing against receivables. Interest rates are prime +2.75% (currently 6.25%) and banks like this product as they get guarantees from the Federal Government
Other options to consider include: selling assets, equipment loans on existing equipment, selling equity to investors (best option).
At Cogent Analytics, we never stop looking for ways to improve your business and neither should you. So, check out some of our other posts for helpful business information:
