A factoring company finances businesses by buying their invoices. So for example, if a company has numerous clients who have yet to pay or are late in paying, that company to try and generate some cash flow can then sell those invoices to a factor. The factoring company will buy the accounts receivable and the client, in turn, gets a lump sum for those accounts. The factoring company will hold that invoice and then once that invoice does get paid, they make a profit on it. Numerous industries often rely upon factors to try and generate some money when payments are late. Such industries include manufacturing, medical offices, landscaping services, IT companies, logistics firms, and these are only a few. In this article, we look at the concept of factoring companies and the pros and cons of working with such a company.
Some Advantages/Disadvantages of Working with a Factoring Company
Perhaps the number one reason why companies will turn to a factor is to get the cash flow going. There is often a great deal of money that can get tied up in late or slow-paying accounts. In working with a factoring company, you get the cash immediately and can therefore pursue other projects. Beyond getting you to cash fast, factoring companies can also help on the end of the collection of things; they can help you with business credit decisions as well as increasing your financing lines.
The question of whether or not you should work with a factoring company will be dependent on a few factors. If for example, your firm gets paid in net 30 to net 60 days then using a factoring company may be a good solution if you need cash quickly. If your clients for the most part have good credit, this is also important in your consideration of whether or not to use a factor. And if slower paying clients cause regular cash flow issues, then a factoring company may be the way to go.
Understanding how factoring works
Working with a factoring company is fairly straightforward. They, as noted, purchase your accounts receivable—most often this is done in two installments. Once you initially sell the invoices to the factor, they will advance you the first sum of money; this amount is usually anywhere from 70 to 90 percent of the total of your invoices.
You will receive the second installment payment once a client pays the invoice. The client can pay on their due date; they do not need to pay the invoice early. This second installment will equal the amount not advanced minus the factoring company's fee.
The cost of using a factor can range, but generally speaking, the fees charged will range somewhere between 1.5 to 3.5% per month. It is however influenced by the volume of invoices as well as the credit history of the clients attached to the unpaid invoices.
Factoring Company Plans
Factoring companies usually offer plans based upon two different payment models: recourse and nonrecourse. With a recourse plan, you are responsible if the client fails to pay the invoice sold to the factor. So, after 90 days, the factoring company can approach you to reimburse them the money they lent you on that particular invoice.
If you are working within the context of a nonrecourse plan you will not have to repay the factor if a client does not pay an invoice as a result of bankruptcy. That said, nonrecourse cannot protect you against late payments. So again, after ninety days if an invoice is still unpaid you will have to reimburse the factoring company. Also, keep in mind, that nonrecourse plans while they offer some protection, they generally tend to be more expensive than recourse plans.
Selecting a factoring company
If you do decide to go with a factoring company for your financing needs, there are certain things you need to keep in mind upon choosing who to work with.
Do they work with your industry?
While many factoring companies just deal, in a broader sense, with any industry or business type, some factors specialize in specific industries. Even if they do not specialize in your industry, it makes sense to work with a factor who has dealt with clients within your industry before.
Do they have competitive rates?
Rates really can vary quite widely from factor to factor. It is a fairly competitive industry and so factoring companies are vying for business. Looking closely at rates and terms is essential to choosing the right firm to deal with. If, however, the rates seem too good to be true you might want to dig a little deeper. Make sure that all information is revealed before you sign on the dotted line and make sure that the factoring company is transparent.
How fast or slow do they work?
In other words, how long will it take them to set up your account and get you funded? The primary issues involved with setting up your factoring account are the review of invoices and documents as well as how quickly they reach out to clients and get them to acknowledge the situation.
How long have they been in business?
It is often better to work with a factoring company that has been in business for a while. This way you know that they are probably reputable and consequently get results. You want to also be sure they do have the money on hand to get you the cash that you need. A fly-by-night factoring company could be more problematic than helpful.
First Union Lending works with small businesses getting them the funds they need when they need them. We have a variety of fast and flexible loan programs available to suit just about any type of business need. With short-term loans and lines of credit among other programs, we have the resources on hand to help you right now. Call today!