Factoring refers to a commonly used financial tool for small businesses whereby a small company sells its goods or services and offers payment terms to the customers as opposed to requiring cash at the time of payment. After these transactions, the business is left with an account receivable that it holds on its books until the customer pays up. This practice may sometimes be referred to as invoice discounting. Silicon Valley factoring companies that specialize in invoice financing offer working capital solutions to small businesses that are non-bankable.
There are many reasons why businesses use this mode of operation. The two main ones are:
- To increase sales
- To develop long-term business relationships
The factoring process
The factoring process is quite straightforward. Acting under a simple agreement, a business sells its accounts receivable to a finance company, in this case, known as the Factor. In return, the business gets an immediate cash advance of the invoice amount. The cash received is usually between 80-90% of the amount.
Invoice discounting is typically conducted under what is called full notification. What this means is that the account debtor is made aware that the invoice has been sold and is directed to make payments directly to the finance company.
The factor follows for payment of the receivable, deducts its fees from the proceeds, and remits the balance to the business.
Is factoring considered debt?
Factoring is not debt. When the account receivable is sold for cash, it remains as that – a sale. Small businesses are often free to enter into factoring arrangements with a finance company even if they already have a relationship in place with a bank.
Is factoring viable for start-ups or other non-bankable businesses?
Businesses can use factoring even if they’re weak or just starting. The determining element in any factoring transaction is the creditworthiness of the account debtor, not the client company itself. This is because the finance company gets paid back directly by the account debtor and not the client.
The business can expect short-term source funding regardless of its financial strength or wherewithal by selling the account receivable, irrespective of its circumstance.
Companies may opt for factoring in the following events:
- Payroll funding
- Slow-paying customers
- Growth opportunities
- Working capital needs
- Government suppliers
- Bank turn-downs
- Operating losses
- Maxed-out lines of credit
- Undercapitalized companies
What are the main types of companies that use factoring?
There are so many industries that rely on factoring as a critical means of finance. Among them are automotive, tech, staffing, healthcare, construction supply, apparel, consulting, distributors, food service, janitorial services, security services, furniture, consumer goods, as well as oil and gas. As a result, factoring is a widely accepted way of raising cash and accelerating cash flow for small and big companies alike.
In a nutshell, invoice discounting refers to the selling of accounts receivable to a third-party to improve cash flow. Given the simplicity of the transactions, factoring arrangements are typically consummated quickly. This usually happens within a few days. Brokering opportunities in this industry are numerous and such businesses are thriving.