Do you have a lot of money your clients owe you in the form of accounts receivable? Do these invoices take time, like 60 days or more, to get paid? Are you in need of cash to finance your next production line? You are not a good credit and are not able to get a bank loan. What can you do?
Factoring may be the answer. Factoring means that you sell your accounts receivable to a factor or third party source at a discount to provide funding. It is a short term solution to your working capital problem. It may help you get on your way to traditional financing.
Here is how it works. You sell your invoices to a factor at a discount and these invoices act as collateral. You would typically receive 80% of the invoice value upfront. You will receive the balance remaining less a factor fee once your client pays the factor. The fee can be paid in any number of ways, but it usually nets out to be about three to five percent of the invoice value. Factoring is not a loan and does not show up on your balance sheet. It is the sale of an asset; therefore, you have no liability here.
To qualify for this factoring, your invoices have to be free and clear of any liens. This means that no other company has a claim on payments when they come in. Your customers must also be creditworthy. Why? – Because the factor will rely on their good credit and ability to pay the invoice quickly rather than on your credit history.
Learn how the factor deals with your clients during the collection process. Does he send out dunning notices with an indication that the factor is to be sent the payment? If the client does not pay your invoice, the factor may ask you to pay back the money he paid you on the invoice plus a fee. Something that is called recourse factoring.
If you decide that you want to seek out a factor, do your comparison shopping by looking at factor fees and the amount of the discount on your total invoices, a deposit or application fee, the advance rate and monthly minimums should also be considered. Factors will not work with start-ups; you need to have a large amount of accounts receivable for the factor to work with you. You can find factors in the telephone directory or in industry trade publications. Your banker may be able to refer you to a factor, but decide on a factor that knows your industry, can customize a service package for you, and has the financial resources you need.