The Facts on Factoring: How to Increase Cash Flow Without Borrowing By Fred Coutts, CPA, CMACash flow is one of
main reasons businesses fail. At one time or another, every business, even successful ones, have experienced poor cash flow. Cash flow does not have to be a problem any more. Do not be fooled -- banks are not only places you can get funding. Other solutions are available and you do not have to borrow.
What is Factoring? One solution is called factoring. Factoring is process of selling accounts receivable to an investor rather than waiting to collect money from customer.
Oh, Irony… Factoring has an ironic distinction: It is financial backbone of many of America's most successful businesses. Why is this ironic? Because factoring is not taught in business colleges, is seldom mentioned in business plans and is relatively unknown to majority of American business people. Yet it is a financial process that frees up billions of dollars every year, enabling thousands of businesses to grow and prosper.
Factoring has been around for thousands of years. Factors are investors who pay cash for right to receive future payments on your invoices.
An unpaid receivable or invoice has value. It is a debt your customer has agreed to pay in near future.
Factoring Principals Although factoring deals exclusively with business-to-business transactions, a large percentage of retail business uses a factoring principal. MasterCard, Visa, and American Express all use a form of factoring in their retail transactions. Using purest definition of word, these large consumer finance companies are really just large factors of consumer paper.
Think about it: You make a purchase at Sears and charge it to your MasterCard. The store gets paid almost immediately, even though you do not make payment until you are ready. For this service, credit card company charges Sears a fee (typical fees range from two to four percent of sale).
The Benefits Factoring can offer many benefits to cash-hungry companies. Rather than wait 30, 60, 90 days or longer for payment on a product or service that has already been delivered, a business can factor (sell) its receivables for cash at a small discount off amount of invoice.
Payroll, marketing efforts, and working capital are just a few of business needs that can be met with this instant cash.
Factoring provides means for a manufacturer to replenish inventory and make more products to sell: There is no longer a need to wait for earlier sales to be paid. Factoring is not just a cash management tool for manufacturers: Almost any type of business can benefit from factoring.
Generally, a business that extends credit will have 10 to 20 percent of its annual sales tied up in accounts receivable at any given time. Think for a moment about how much money is tied up in 60 days' worth of invoices: You cannot pay power bill or this week's payroll with a customer's invoice, but you can sell that invoice for cash to meet those obligations.
Factoring is a fast and easy process. The factor buys invoice at a discount, usually a few percentage points less than face value of invoice.
