Factoring may not be the oldest profession in the world, but it may not be far from it. This specific financial practice has its roots back to the Roman Empire. Before the Revolution, factoring was deemed as the best form of finance in the American colonies. It was mainly seen in the textile firms. However, over the past few decades, consolidation has created two separate kinds of funding sources known as factors. These would be bifurcated into large, institutional-owned factors and small, independent factoring companies.
What do you mean by factoring?
Factoring would be best defined as the purchase of a business accounts receivable at a specific discount. Instead of waiting for 30, 45, 60 days or even longer for the receivable to be paid, the factor would buy the invoice and provide you with 80% of the advance money. The client would be required to complete an application first. It would be inclusive of a wide list of receivables to be factored.
However, the funding source would then submit a proposal to the client. This would be inclusive of an estimate of the factor fee. In case, the client would accept the proposal, the next step would be to submit a check for due diligence. The factor should research not only the client, but it should lay emphasis on the credit standing of the debtors.
However, after due diligence has been performed, the factor would advance 70%-80% of the invoice balance to the client. When the customer would pay the invoice that would be made directly to the factor, the client would receive the remaining balance less than the factor’s fee. The factoring process can be broken up into two parts: the initial account setup and ongoing funding.
Why companies needs factor?
The major reasons for companies to factor would be as follows:
You should consider the situation of being a profitable and growing manufacturing company that would make use of credit lines extended by the bank. The customer would come to you with large order that requires to be filled quickly. You should come up with cash for production or forego the order to the competitor. It may cause losing the customer forever. Factoring the existing receivable would provide easy financing for filling the order along with increasing the profits of the company.
The cash flow of the company has been significantly tight for funding the payroll, meet expenses and pay taxes. They may not wait for a customer to pay the bill 45 days down the line.