If you weren’t keen on mathematics and have not so fond memories of factoring, you may just ignore factoring as finance.
But there is no need. Factoring in a finance sense is rather simple.
Factoring is the sale of your invoices or accounts receivable for money in the bank and it is a Factor which purchases the invoices for an agreed discounted sum.
The mechanics are also simple, rather like the early Ford and nothing like a V8 racing car.
Your company sells a product to a customer and delivers an invoice to that purchaser. The purchaser agrees to pay the invoice according to the agreed terms, 30 or 60 days or similar. You the seller must pay your supplier for the materials which made the product you sell. The Factor then buys the invoice at a discount and you have money to pay your expenses, buy extra equipment or just grow your business in general. Of course the last step in the process is your customer pays the invoice to the Factor.
- So there is the “advance”, the sum which is paid to you by the Factor when they receive your invoices.
- A reserve amount which will be paid to you by the Factor when they are paid by your customer.
- Then the fee for the Factor. An amount which is agreed upon at the very start.
The Factor will be diligent though when entering into an agreement prior to purchasing any invoices. The simple fact to remember, it is the financial strength and stability of your customer is one of the most important issues and the Factor will verify who the customer(s) are. This has an added benefit, the work done by the Factor will establish just how credit worthy they are.
With this type of financing, your accounts receivable is an “asset”, it is no longer an “illiquid” asset which is normally not an asset easily converted to cash.
The simplicity aspect of factoring lies in the difference to this finance versus a bank loan. Yes, there is still paperwork and the Factor needs to know enough to enter into the agreement but it is a more straightforward process which also takes much less time for approval to take place.
Think of factoring as outsourcing your credit management. It makes your job simpler. A Factor is however, not a debt collector and if a debtor ever falls into the too hard category, that requires a different company to handle it.
Once you have used factoring, you may continue to use it on a regular basis or just use it in emergency situations. It is your choice but it is a good relationship to establish.
Factoring does give you flexibility, cash flow and working capital all without the hassle.