How You Can Help Your Business Grow

HOW YOU CAN HELP YOUR BUSINESS GROW
Natalie Tackett, CCFC

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 typically are sold on credit. The buyer doesn’t have to pay for the product immediately. In fact, they may have 30, 60, or even 90 days to pay. This is called buying on terms.

Competitive Edge

Offering credit makes a producer more competitive in the marketplace. Businesses can buy products from many different vendors. If the only difference between vendors 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, it doesn’t get a receipt for the sale, usually, it receives an invoice.

An invoice is a bill that lists how many goods were ordered or the type of service that was provided, how much the goods or services cost, and how many days the buyer can take to pay for them. The invoice resulting from the commercial sale creates a debt that one business owes to another business.

Factoring

The process of transacting accounts receivable in 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' 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. As opposed to loans and lines of credit that require the client have tangible assets and strong financials, factoring relies more heavily on the financial strength of the clients' customer.

Many businesses that apply for bank financing, especially small to mid-sized companies, 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 out money. When evaluating a loan application, banks must consider the amount of assets that a business has to secure the loan. Those assets are called collateral. Banks generally require a great deal of collateral to secure a loan for a business. A business may be generating $1,000,000 a year in sales-obviously a good volume of business-yet own a few assets that would secure a loan.

If a bank is willing to lend against accounts receivable, the bank 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 probably would lend only 30-50% of the total amount.

Factors, on the other hand, are not subject to the same regulations that banks are, because factoring is an outright purchase, not a loan. Factors may advance up to 90% or more of a business’s accounts receivable.

Banks base their financing on the strength of the business applying for the loan, not on the business’s accounts receivable. Even if a business’s customers have solid and reliable credit, the bank still will not give a client a loan unless the client’s business has a strong financial statement independent from 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.