One of the oldest forms of business financing, factoring is the cash-management tool of choice for many companies. Factoring is actually very common in certain industries, such as the clothing industry, where long-term receivables are part of the business cycle. Factoring can be traced back over 2,000 years, when factors were used by farmers and merchants to maintain a stable flow of cash required to provide goods to the market. Invoice factors also helped fund early growth and expansion in America and support the new enterprise required in the emerging Colonies.
In a typical factoring arrangement, the client provides a product or service and generates an invoice. The factoring company buys the right to collect on that invoice by agreeing to pay some percentage of the invoice’s face value. This percentage paid varies greatly, depending on the risk factor involved in the receivable and the likely amount to be collected.
Because factoring companies in effect extend credit not to their clients but to their clients’ customers, they are more concerned about the customers’ ability to pay than the client’s financial status. That means a company with creditworthy customers may be able to factor even if it can’t qualify for a loan.
Factoring is not a loan; it does not create a liability on the balance sheet or encumber assets. Rather, it is the sale of an asset–in this case, the invoice. Factoring is often viewed as an expensive method of financing; however, this is not always the case. Factoring companies help eliminate the risk and cost of collections for your company. They take over the accounting and administrative processes involved in collecting on the receivables. They provide cash flow you can use for other revenue generating projects.
Many modern, successful companies continue to use factoring strategically to manage cash flow needs, either on an ongoing basis or utilized as needed to fund specific capital projects.
