How Does Factoring Work?

by : Thomas McCarthy

Step by Step Instructions on How to Leverage Factoring for Your Business
Do you need access to short term cash to grow your business? Factoring is an effective strategy that allows your business to borrow against its invoices or accounts receivable for a small fee. This will allow you to gain access to your hard earned dollars quickly so that you can reinvest them into your business or to pay outstanding invoices. Waiting for a vendor or client payment can be frustrating, especially if it is over a month or more away. Factoring offers your business an affordable financing solution.

How does Factoring Work?
Factoring is a finance tool designed to allow businesses to access cash quickly so that they can use it to operate and expand their businesses. One of the most attractive features of factoring is that it is actually not a business loan; it is an advance payment based upon invoices or accounts receivable owed to the business. The process of factoring is quite simple; first, the factoring company purchases an invoice from your business at a discount. Next, the factoring company will work to collect the invoice payment. Once they have collected the business payment, they will pay your business the rest of the amount owed. The fee that the factoring company charges will vary based on the volume of business that you do with them, the length of time that the invoice takes to be paid and in some cases, the credit of the company that owes your business money.

There are 2 primary forms of factoring: recourse and non-recourse. Companies that use recourse factoring make your company liable for any invoices that are not paid in full. Non-recourse factoring takes the risk of the invoice when they choose to purchase it from you. Factoring companies that leverage the non-recourse strategy will generally offer your business a lower purchase price to compensate for the added risk that they are taking. Depending on your current invoice payment history, you should choose the most financially viable option for your business.

Advantages of Factoring
When a business is evaluating available financing options, the process can become overwhelming. Also, if the business does not have established credit or the business owner does not want to co-sign on the debt, there are very limited financing options available. Factoring is not considered debt to the business and is not a form of a business loan. In fact, factoring companies are not concerned with your business's debts; they are only concerned with the credit worthiness of the company that they are buying the invoice for. With this in mind, factoring is a great strategy for companies that are not only new, but those that have a short track record, weak financial statements or who cannot get traditional financing.

Another major advantage of factoring is that your business can receive cash flow earlier, typically in 1-2 business days rather than waiting for your customers to pay their invoices. While you are paying a nominal fee for the factoring services, the process speeds up, allowing you and your business to leverage those dollars to grow your business.

Factoring companies are also generally more effective at collecting payment for invoices as they specialize in this and have the dedicated resources to focus on this task. In comparison, your small business may not have those resources allocated to collect your invoices as efficiently or effectively.

Here are some additional benefits of factoring for your business:
* Early Payment Discounts: With factoring, you will be in a position to pay your own invoices early, possibly being able to take advantage of early payment discounts.
* Build your Business Credit: By paying your bills earlier, you will be helping your business to build its credit with other businesses and important vendors.
* Flexibility: Many factoring companies do not require you to factor all of your invoices. This will allow you to choose the invoices that you would like to factor; for example, if most of your customers pay quickly, you will only want to factor invoices of customers that are slower to pay. Also, you would want to focus on larger invoices for factoring as you may have depleted cash flow to fulfill those larger orders; cash flow earlier will help you to gain the much needed profits on these larger sales.

Process for Implementing Factoring within your Business
Factoring provides several advantages for businesses of all sizes. Follow this step by step guide to allow factoring to work for your business:

Step 1:
Research a variety of companies that provide the type of services that your company requires for financing, starting by deciding whether you are going to use a non-recourse or resource factoring company. You can search using your search engine, by using the local phone book or by asking for referrals. Choose 3-5 that you will compare and contact each one so that you can speak with a live representative. Ask questions so that you fully understand their program and their fees; make sure to ask what all of their fees are and their average turn around time to fund an invoice once it is submitted.

Step 2:
In addition to the brief mention above of comparison, you will also want to read the factoring company's policy and procedures, time lines, feedback from previous customers and you will want to review the company's application. While fees are certainly a consideration, compare the companies to choose the best balance between cost and service provided.

Step 3:
Now that you have narrowed down the factoring companies to 1-2 finals, schedule additional phone time to speak with a representative. Review the contract with the company representative to ensure that you understand all of the details. Probably to most important thing that gets overlooked is the fine print as it relates to fees. Just like in any financial transaction, you will want to read through and understand time lines, what can cause a fee to increase or decrease and anything else that is specific to this factory company's restrictions and guidelines. Also, be sure that you understand how the percentage payments change by 30, 60, 90 and 120+ day payments.

Step 4:
Now that you have a full understanding of the company and the paperwork, you are ready to get started. Organize your paperwork and submit it to your chosen factoring company.

Step 5:
Once you have been approved, you will need to develop a system to send in your invoices. If you currently manage this process, add time into your calendar to manage it. If you are going to use an administrative person, make sure that you go through the details and the paperwork for them to accurately complete. Once you submit your first factoring invoice, within a few days you will receive your first payment.

By implementing these steps, you will be able to leverage factoring within your business structure. Factoring can help your business to pay down expenses quicker and also to focus on growth.