Factoring for Businesses
Factoring is flexible alternative financing, where the fund’s receivers assume no debt. A business owner actually sells the businesses’ invoices to a financier. The reason owners participate in factoring for businesses is because they are in need of cash immediately and cannot wait the standard 60 to 90 days for invoices to be paid.
Customers do not know that the business is participating in factoring. In fact, factoring is an excellent solution to help businesses maintain their cash flow.
Lending parties are willing to purchase accounts receivable and invoices for several reasons.
1. Lenders purchase accounts receivables at discount prices, then collect the full amounts from customers.
2. Factoring companies are assured repayment of funds because they receive an actual invoice, allowing them to demand payment in full from customers. The bill of sale or actual invoice acts as a guarantee or collateral for fronting funds to the business owner.
3. Three main parties are involved in a factoring transaction. The factor is the lending party. They purchase the receivables or invoices from the business owner. The business owner then holds the invoices, selling them for a cash discount. The debtor is the customer that is billed for the product or service. The invoice then becomes a financial asset and is collected on behalf of the factor.
Factoring is used in many industries, especially manufacturing, where raw product is sufficiently greater than cash on hand. Companies require raw products to meet customers’ demands, but they cannot purchase enough products to meet requirements. The manufacturing companies then turn to factoring to help draw capital from future invoices to help purchase products and maintain customer orders.
When the factor buys a receivable, the payment is usually collected themselves. When the invoice is purchased, the customer is then notified they will be paying a third party. The factor is then able to recognize the receivable as a financial asset on their books and can promise or exchange the asset without any restrictions from the debtor or borrower.
When a factor takes on new ownership, this occurs without any resource. It is up to the new owner to collect funds and monies and they are solely to bear if they are unable to collect. If the factor does receive the invoice with recourse, they are permitted to collect any unpaid invoices from the borrower. There are structured factoring scenarios, including expenses and fees associated with factoring. Generally, the business owner considers factoring as a capital shortfall.