A factoring company is a business enterprise that makes available financing to companies that have cash flow issues owing to slow-paying invoices. These businesses purchase accounts receivable from their clients at a small discount. They work to ensure that the client can get immediate funds from the sale of their receivables, and this helps to settle their financial challenges.
Working with factoring companies has grown to become a viable alternative for financing, especially for business establishments that are experiencing cash flow issues owing to slow-paying customers, seasonal highs and lows, or rapid growth.
Have it in mind that businesses that work with these companies are not borrowing funds and are not expected to pay them back. Rather, they are getting advanced on their own money.
The primary benefit these companies offer to businesses is that they make available cash quickly, particularly within 24 hours. Since it is so fast and simple, B2B (business-to-business) companies tend to see it as a wonderful funding solution for unsteady cash flow.
Since your funding is based on outstanding invoices, factors look at the credit history of the businesses your company invoices, not you.
How Do Factoring Companies Work?
The way these businesses work is quite straightforward and this makes them very easy to use. In most situations, the factoring company purchases the receivable in two installment payments. The first installment is referred to as the advance and is funded at the point where the factor buys the invoices.
The advance is usually around 80% to 90% of the invoice. Advances are known to differ depending on the risk profile of the transaction.
The remaining 10% to 20% of the invoice, less a small factoring fee, is advanced as a second installment immediately after the end client has made full payment on the invoice. You have to understand that this particular payment is what settles the transaction.
Howbeit, note that in certain industries, such as trucking and staffing, businesses are known to be eligible for higher-than-average advances. In some instances, the said transactions can be carried out with a single installment advance as high as 98%.
How the Factoring Process Works
Just as was noted above, the way these businesses work is quite straightforward and this makes them very easy to use. Nevertheless, to ensure you have a comprehensive idea of how they work, below is a guide on how the factoring process works.
Table of Content
Contact a factoring company
This is without doubt the very first stage in the process. Most often, these factoring businesses work with small to medium-sized companies that more or less focus on specific industries. Ensure to align with factoring companies that boast of experience and years working in the industry. This goes to prove that they have the financial wherewithal to survive economic cycles.
Application and due diligence
After finding the right company to work with, the next step will be to fill out and submit the financing application. Have it in mind that each factoring company has its own application process, though they are all similar. Factoring companies will want you to fill out the application extensively to ensure that they can evaluate the transaction and check if it’s a good fit for both parties. Within these processes, they are known to evaluate if your:
- Clients have good credit
- Invoices are free from liens
- The company possesses no major problems
Proposal and contract
The factoring company will then forward its proposal to you after analyzing the transaction. Most often, the proposals tend to possess three key pieces of information:
- Advance rate (1st installment)
- Factoring rate
- Length of term
Note that immediately after you put pen to paper on the proposal, the factoring company will carry out its final diligence and forward the contract to you. Once you sign the contract, your account will be furnished with the first funding.
Initial account setup
Within this particular phase of the process, the factoring company will forward a Notice of Assignment (NOA) to every customer whose invoices you are looking to factor. The NOA refers to a standard industry document and it is utilized by every factor.
It serves to direct the customer’s accounts payable department on the exact way to handle invoice payments. This process is carried out once for each customer.
Have it in mind that every factoring company possesses its own submission process, though they are all similar. Howbeit, note that it starts with sending in the invoices you intend to finance through an online portal or by email. Once the company acknowledges the receipt of the invoices and verifies the invoices, they deposit the first installment (advance) in your bank account. Your repeat this step every time you are looking to finance invoices.
This is considered the last phase of the factoring process. Note that the factoring company settles each transaction when the owing customers make payment on their invoices. Have it in mind that immediately after it is paid, the factor remits the remaining 20% (less the fee) to you, as the second installment. You have to understand that this particular deposit settles the transaction.
Aligning or working with factoring companies has grown to become a viable alternative for establishments that are experiencing cash flow issues owing to slow-paying customers, seasonal highs and lows, or rapid growth.
The primary benefit that these companies offer to businesses is that they make available cash quickly, particularly within 24 hours. Since it is so fast and simple, B2B (business-to-business) companies tend to see it as a wonderful funding solution for unsteady cash flow.