Many companies can benefit from a process in which their receivables are collected by a third party through a process known as factoring. Many companies aren’t familiar with the process of invoice factoring and see it as a net cost to the overall business as opposed to an opportunity to structure your business. Understanding the options out there for factoring receivables provides significant opportunities for a business.
What is Business Factoring?
When a company factors their receivables, they push the process and risk of collecting on their receivables to a third party known as a factor who handles the collections for them. If the customer defaults on paying the invoice or goes bankrupt, the factor will ultimately lose out on the collection.
Typically speaking, once the sale is completed, the company will provide information to the factor including the contract, the invoice, support for the delivery of the product or service, and any other information needed to collect on the receivable such as customer contact information. The factor will then handle the collection process and will lose out if the receivable is not collected or benefit when the receivable is collected. The factor will typically pay the company for the sale shortly after the sale is completed.
What are the Benefits of Business Factoring?
A business factoring their receivables will benefit from the factoring process in a variety of ways. Collecting receivables can be a real challenge for a business and serve as a true distraction for a company. Many companies even need to involve their executives to assist in collection which can be a real disruption of the business. Factoring allows a business to focus on growing the company as opposed to causing the distraction that collecting receivables can pose to a company.
Factoring a receivable provides a predictable cash flow for a business, that can be used to finance operations. When a company factors their receivables, they know where and when their cash will be coming in from and can more effectively plan for their cash needs going forward. This takes out of the process many of the risks and a company can have a better basis for growing their business rather than trying to figure out how to make their payroll each month.
The process of collecting receivables from businesses sold to or to other individual customers can prove a source of friction for the business and its customers which can be avoided with the use of a factor. Factors can handle the collection process on behalf of the business and many customers will understand that a factor is a third party and won’t resent the company for pursuing customers through a factor. This is particularly true when a company has challenges with certain customers or when the world is entering a recessionary period.
Companies can benefit from using a third-party factor to have a more streamlined accounting staff, which can be particularly helpful for smaller businesses. Many smaller businesses will not need to hire dedicated customer employees and can save on their payroll as a result.
Cost of Factoring
There is a cost of factoring your receivables, which is determined based on a meeting with a factor and is typically based on the risk of collecting each receivable. Overall, a factor can reject a customer and a company can decide to sell and collect the receivable independently from the factor. The factor charge can fluctuate widely based on how risky each receivable is but will typically be from 1-5% of the sale price.
The cost for factoring is very real but so is the opportunity out there. A company should consider if factoring is right for them and weigh the benefits and risks of factoring, but should not ignore this as an option given the benefits of business factoring.