The Basics of Factoring

What is receivables funding?

Factoring is where an advance of cash is made to a Client against the purchase of an accounts receivable by a financing company (aka Factor). The Factor then proceeds to collect the receivable. The balance of the receivable less any fees due to the Factor is then payable to the Client on collection of the receivable by the Factor. Factoring is an effective way for a business to finance growth or to assist in the restructuring of a business. It also does not lead to any loss in equity of your business nor does it involve taking specific security over personal assets.

For instance, you sell your good or service to your customer in the normal course of business. Once your side of the transaction is complete and your service has been provided or your product delivered you generate an invoice for your customer that states they owe you X dollars within 30 days for what you have given them.

At this point you would normally have to wait those 30 days (payment is always right at that 30 day mark, isn't it?...) prior to receiving the cash you are owed. Factoring changes that.

When you factor your invoices the factoring company will advance you a percentage of the invoiced amount shortly after the invoice is created. This percentage is usually between 80 - 90% of the gross invoice amount. So instead of having to wait those 30 days for your cash, you are able to receive the majority of it almost immediately after you deliver your good or service.

The difference (that 10 - 20%) is held by the factoring company until your customer makes their payment through a lockbox. Once the payment is made, you get all of that back minus the fees for the service.

Fees range quite a bit between different companies and are structured based upon your customers' credit and the amount of invoicing you do and the factoring company's cost of funds (what their money costs them), but are generally small compared to what can be done with the available cash. There are some instances I have seen where companies actually come out ahead of the game and are effectively PAID to factor their invoices. This can happen when a company is able to take advantage of early pay or bulk discounts from their suppliers (sometimes enough by itself to cover the cost of factoring) and is able to put the free cash to use. It is truly an amazing concept! I believe Warren Buffett calls it negative float for his insurance businesses.