Financial Factoring Defined

Compliments of Wikipedia.org

Factoring is often used synonymously with accounts receivable financing. Factoring is a form of commercial finance whereby a business sells its accounts receivable (in the form of invoices) at a discount. Effectively, the business is no longer dependent on the conversion of accounts receivable to cash from the actual payment from their customers, which takes place on typical 30 to 90 day terms. Businesses benefit from the acceleration of cash flow by obtaining cash from the factor equal to the face value of the sold accounts receivable, less a factor's fee.

Factoring is considered off balance sheet financing in that it is not a form of debt or a form of equity. This fact makes factoring more attainable than traditional bank and equity financing.

There are usually three parties involved when an invoice is factored:

• Seller of the product or service who originates the invoice.
• Debtor is the recipient of the invoice for services rendered who promises to pay the balance within the agreed payment terms (the customer).
• Factor (the factoring company)

Types of factoring:

• Notified, or full service factoring:
  With notified factoring, the debtors are aware of the finance facility as the factoring company normally does the credit control, that is, collects the outstanding debts.
  
• Confidential, or invoice finance:
  With invoice finance (sometimes called confidential or non-notification factoring), the factoring facility is undisclosed, with the seller usually retaining the credit control function.
  
• Recourse factoring:
  Recourse factoring is now the most common type of factoring transaction. This factoring transaction allows the factor to go back to the seller if payment is not received (normally after a 90 day period). The credit risk does not transfer to the factor during the recourse factoring process. Normally, in the event of non-payment by the customer, the seller must buy back the invoice with another invoice (credit worthy). Recourse factoring is typically the lowest cost for the seller because the risk for the factor on the funding transaction is lower.
• Non recourse factoring:
  Non recourse factoring is the traditional method of factoring and puts the risk of non-payment, in the event the debtor becomes insolvent, fully on the factor. If the debtor cannot pay the invoice due to insolvency, it is the factor's problem to deal with and the factor cannot seek payment from the seller. The factor will only purchase solid credit worthy invoices and often turns away average credit quality customers. The cost is typically higher with this factoring process as the factor assumes a greater risk.
• New Company Factoring
  Sometimes, because the seller is a new company, it may find it difficult to secure traditional bank financing. An alternative source of financing in such an instance is to use use factoring by selling accounts to a finance company (the factor) in order to gain immediate access to the cash owed to the seller by its customers. Instead of sending bills directly to the customer, the company sends its invoices to the factor, who immediately pays the company–thereby eliminating the 30, 60, or even 90 days of waiting that normally encompasses a billing cycle. For example, suppose a manufacturing company secures a contract to sell its widgets to a large retailer. Upon delivery of the merchandise to the retailer, the manufacturer sends the bill through the factoring company for payment. The factor immediately pays the manufacturer the face value of the invoice less a discount fee (2–10%), depending on the nature of the contract and the creditworthiness of the retailer. This immediate access to the cash flow allows the manufacturer to meet its commitments and pay its bills in a timely manner. The retailer pays the factor when the bill comes due for the widgets it purchased from the manufacturer.
  

Smart Factoring Strategies:

When more flexible terms factoring begins, the client can increase prices to its customers by 1% to 5% to help cover the cost of factoring.

In many industries, customers expect to pay a few percentage points higher to get flexible sales terms. A client can seek a cash discount from a supplier in return for prompt payment, many time from 2% up to 10% (depending on the industry standard). When a client makes a cash payment on the day of purchase from suppliers, the client can profit from a large cash discount.
With benefits availing to both the supplier and the customer, the cost of factoring can be covered by using smart factoring strategies.

Factoring has been available to a variety of companies for many years. Some factors specialize only in retail financing, others specialize in freight-bill factoring for trucking companies, and others only factor invoices for manufacturing companies. Factoring may be more expensive than traditional bank financing but often it is the only source of financing that some new or under-capitalized companies can find.

If you would like to see if factoring your accounts receivables can help your business please contact Universal Funding Corporation at 1-800-901-2418 or visit us online at www.universalfundingmain.com