Factoring

Factoring

Factoring is the act of selling businesses accounts receivables. By selling your accounts receivables you generate cash sooner than if you collected the money on your own. The company that purchases your receivables takes the title to the invoices and has the responsibility of collecting them. That company also assumes all of the costs associated with the collection process.

Some banks, commercial finance companies, and a variety of other types of financial companies will purchase receivables. For businesses with less than $10,000 of monthly receivables, it may be hard to locate a factor company willing to purchase those receivables. Some areas have factoring "brokers" that can assist small businesses in locating a suitable factor company that may be willing to purchase your receivables.

The major disadvantage to factoring is that it is expensive. Factor companies will sharply discount the cash price of your accounts receivable. Your final cost will almost always exceed the amount that would be paid in interest on a short-term commercial loan for an equal amount. Furthermore, because factoring requires accounts receivable, it is limited to existing businesses.

Factoring is mainly used by quick growing businesses with annual sales between $125,000 - $10,000,000 that have temporary cash flow problems. In a few select industries, such as the garment industry, factoring is used on a long-term basis.

The advantages of factoring are:

Quick cash
No debt
The elimination of collections

The disadvantages of factoring are:

Cost
Potential damage to your customer relations

Factoring agreements are usually flexible. You should always try to negotiate for the best terms possible. Negotiation for a lower discount percentage is frequent in factor relationships. Be aware that the most negotiable charge is usually not the initial discount percentage. The other charges associated with factoring, such as an initial user fee, are typically more negotiable.

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