How To Grow Your Business

Many small to medium sized businesses have a roster of financially strong customers that can be leveraged. They may have yet to discover that their business can actually capitalize on their own customer base through a process called factoring. In commercial transactions, goods are typically sold on credit. The buyer may have 30, 60 or even 90 days to pay for a product or service.

Competitive Edge

Offering credit makes a producer more competitive in the marketplace. Businesses can buy products from many different vendors and if the only difference is their payment terms, buyers will often choose the vendor that offers the longest period of time to pay for the goods. Businesses generally want to hold on to their cash as long as possible. When a commercial customer buys on terms, they do not receive a receipt for the sale, but rather, an invoice. This invoice creates a debt that one business owes to another business.

Factoring

The process of transacting accounts receivable through the secondary market is called factoring. Factoring is the purchase of accounts receivable from a business at a discount.  Factoring allows businesses to collect the money they are owed immediately by accepting a discounted amount of the invoice from a third party. In a factoring transaction, a business sells one or more invoices to a factor. A factor is a funding source that specializes in funding accounts receivable. With factoring, companies immediately collect for their invoiced work from the factoring finance company while the factoring company waits to be paid by the customers. Factoring strengthens a business's cash position by shortening the time to get invoices paid to 48 hours and providing the needed funds to meet current expenses and target new opportunities.

How Factoring is Different From a Bank Loan 

Factoring is not a lending service, but rather a discounted purchase. A factor typically does not charge interest and simply buys invoices at a discount and collects a fee. Loans and lines of credit require the client have tangible assets and strong financials; factoring relies more heavily on the financial strength of the client's customer.

Many businesses that apply for bank financing, especially small to medium sized businesses, are turned down. Banks must follow very rigid guidelines established by the FDIC. They are required to maintain a certain level of capital or equity in order to lend money. When evaluating a loan application, banks must consider the amount of assets, or collateral, a business has to secure the loan. A business may generate $1,000,000 per year in sales yet own few assets that would secure a loan.

If a bank is willing to lend against accounts receivable, it may structure the loan based on the size of a business's accounts receivable. If a business has $100,000 worth of outstanding invoices, the bank would probably only lend 30-50% of the total amount.

Factors are not subject to the same regulations as banks because factoring is an outright purchase, not a loan. Factors may advance up to 90% or more of a company's accounts receivable. Even if a business's customers have solid and reliable credit, they still may not give a client a loan unless the client's business has a strong financial statement independent of the accounts receivable. When a business enters a factoring arrangement, the factor bases the purchase on the credit of the business's customers, not on the credit of the business itself.