Factoring
Get help with your invoicing and receivables
By William Addison
If delayed payments from your customers are putting a cash crunch on your business, then factoring may be the answer. Factoring, which includes receivable factoring, cash flow factoring and invoice factoring, involves the sale of your invoices or receivables to a third party, known as the factoring company or factoring broker. In return for the cash you get up front, you pay a fee for the factoring service.
How Factoring Works
The first thing to be aware of is that this process is generally designed for companies who deal with the same customers on a regular basis. A factoring company will require that you sign a separate agreement for each of your customers. The agreement will state that you promise you will not accept any payments directly from your customer, but that the customer must send the payments to the factoring company. This agreement is a separate document from your basic contract with the factoring company.
The second important thing you need to be aware of is that the factoring company will be charging you a fee for every invoice. The fees will be a percentage of the invoice, and that percentage will range from 3 to 10 percent. This range is variable based on the length of time it takes for your customer to pay - if your customer pays early, you'll pay a lower fee, but if they pay later, you will pay a higher fee.
A third important consideration is the hold-back or retainer. A factoring company takes a risk by paying you up front for your invoices. In order to limit that risk, they won't pay you for the whole invoice up front. Instead, they’ll hold a significant amount until they actually receive the money from your customer. A hold-back of 20 percent is not uncommon, so be prepared to wait for 20 percent of the amount of your invoices until your customer ponies up the dough.
The last and most important consideration relates to non-paying customers. If your customer does not pay, the factoring company can come after you and recover the money they paid you on that invoice. Some factoring companies will enter an agreement with you on a "non-recourse" basis, which means they will release you of any liability should your customer not pay. This is obviously a better arrangement for you as you are then protected from non-paying customers. Say goodbye to your hold-back however, as this retainer will be kept in most cases.
Other Features of Factoring
In order to obtain all of the advantages that a factoring company can bring to your accounts receivable report, you will have to sign some sternly worded contracts, so be sure to have your attorney review them before you sign. You will also be required to obtain very specific agreements from your customers regarding your invoices. You basically need to have proof from your customer that the invoice is legitimate, and that they fully agree that they owe the money to you.
Aside from receiving the benefit of early payment with a factoring company, most will also perform free credit checks on your customers. This is an advantage to them because they receive assurance that your invoices will be paid eventually. It’s an advantage to you too, because if the factoring company won't accept your customer as a risk, you probably don't want to either.
Factoring can be a big help to a small company that has little working capital. It's not the answer to all problems, and it certainly isn’t the answer for every company, but it’s worth consideration for many small businesses that have their eyes on growth.
