What is Factoring?
Factoring, also known as invoice financing, is a financial transaction in which a business sells its receivables at a discount to a third-party company called a factor. In a typical factoring arrangement, the factor purchases the receivables and assumes complete responsibility for payment collection. The factor usually purchases the receivables in 2 installments: a factoring advance of the receivable that is paid up front, and a rebate of the remaining balance (minus factoring fees) after collecting the full payment from customers. This alternative form of financing enables businesses to generate immediate debt-free working capital.
How Long Has Factoring Been Around?
The practice of factoring has been around for centuries with the financing of trade. It is said that factoring got its start during the Mesopotamian Era around 1772 BC, and gradually became a common financial practice prior to the 1400s in England. The Pilgrims then brought factoring with them to America in the early 1600s. Today, factoring continues to be used as a cash flow solution for many businesses.
How Much Do I Need to Factor?
There is no specific amount of receivables required to factor with Growth Capital. Invoice financing with us gives you the freedom to decide how much you want to factor and when. Subsequently, businesses have the ability to create factoring arrangements that would best suit their budget and needs. Your factoring arrangement will also determine the kind of relationship you will have with us. Here are the 3 common options for invoice financing:
- Whole Turnover Factoring The most conventional factoring arrangement. It covers the entire receivables of a business. We finance all your invoices for each and every customer. Costs for the facility will be determined by your whole turnover.
- Selective Factoring A flexible factoring approach that allows you to choose the customers you want to factor. You get to pick which invoices of those customers you would like to finance.
- Spot Factoring (Single Invoice Finance) In this ad hoc factoring approach, you sell a single invoice or a group of invoices to us, which we finance without entering a long-term relationship.
What Are Some Other Benefits of Factoring?
Factoring is a cost-effective way to raise working capital for your business. Some other benefits of factoring include:
Quick Approval and Fast Access to Working Capital
Setting up an account only takes around 2-5 business days. Factoring cash advances are usually directly deposited in your bank account by wire or EFT (Electronic Fund Transfer) within 24–48 hours.
Easy Qualification Criteria
Gaining approval for factoring is dependent on the creditworthiness of your customers. You are not required to have a long business financial history or high credit ratings to qualify for factoring.
Improved Cash Flow with No Debt
Factoring instantly increases working capital which can be used to regulate your business’s cash flow. It is not a loan, therefore there is no risk of accumulating any debt on your balance sheet.
Unlimited Funding Potential
The amount of funding given through factoring grows with your business sales. As your sales increase, there will be more receivables to finance and more funds available to you.
Different factoring arrangements have different terms and costs. Businesses may pick and choose which receivables to factor, how often to factor the selected receivables, and when to factor them.
Save Time and Resources
The factor manages the credit control functions for your business which helps to reduce overhead costs spent on a collections department. This leaves you with more time and resources to grow your business.
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How Much Does Factoring Cost?
The cost of factoring (excluding any additional fees) is called factoring rate or discount rate and represents the percentage discount that the factor charges for its services. The factoring rate varies across factoring companies and industries. A factor will evaluate 2 main variables to determine its fees: the risk of purchasing a business’s receivables and the factored volume. The risk of purchasing receivables largely depends on the creditworthiness of the customers and the type of industry that the business is in. Since factoring is volume based, factoring companies will assess the business’s monthly factored volume size. Consequently, businesses that have low-risk transactions and a high factoring volume tend to receive lower factoring rates. Businesses with high-risk transactions and a low factoring volume are likely to receive higher factoring rates.
The factoring advance is the percentage of the invoice value that your business will receive upfront. Factoring advance rates can range from 80% to as high as 100% of the invoice face value. The remaining portion of the invoice is held as a reserve by the factor until invoice is paid in full. Then the reserve is released in a form of rebate. The purpose of the reserve is to ensure the factor is fully reimbursed and the reserve is drawdown only in case the invoice is short-paid. The percentage of the factoring advance rate varies from industry to industry, and it is determined at the beginning of factoring relationship.
Invoice Factoring Requirements
To be eligible for invoice factoring, you must:
Sell products and/or services to other businesses
Invoice factoring is only available to businesses selling products or services to other businesses (B2B).
Have unencumbered invoices
Invoices have to be free of liens; they cannot be pledged as collateral to other institutions.
Have creditworthy customers
Since payments are made by your customers, it is essential to have reliable customers that will pay their invoices on time.
Various kinds of companies across different industries have implemented invoice factoring to fund their business as a way to raise immediate working capital to meet specific business needs. Examples of industries using factoring services are:
Transport businesses may experience cash flow problems due to slow-paying customers. They would need funds to pay for regular expenses that includes maintenance and repairs, fuel, tires, and driver salaries.
Invoice factoring helps wholesalers, distributors, and supply chain partners to raise the necessary funds to pay suppliers. A steady cash flow is also needed to cover ongoing wholesale operating costs.
The medical and health-care industry is known for having long payment timelines. It can take months for medical claims to be paid. Health-care providers may need funds for operating expenses such as medical equipment and supplies, facilities, and staff salaries.
Staffing companies commonly deal with customers that make payments on a monthly basis. Funds from factoring invoices are often used to cover payrolls.
Many construction companies have to handle upfront expenses and daily operational costs. Invoice factoring provides a short-term solution for finished stages of a project or a completed project.