Frequently Asked Questions about Factoring

What is Factoring?

Factoring is the purchase of accounts receivables (invoices) by a factoring company in order to provide a business with immediate cash flow to grow its business. Factoring is a widely accepted financing option used by companies of all sizes. Factors provide corporate financing to businesses; but they are neither retail nor consumer financing companies.

How does Factoring work?

A business sells an invoice to a factor at a discount. When a client’s customer remits payment for the invoice to the factor, the client will receive the balance of the invoice face value held as reserve by the factor, less the discount fee.

The discount fee is the compensation to the factor for its risk taking for the advances it makes to its clients, and for the credit and collection services it has provided. The amount of factoring discount charged varies with the sales volume of the client, the size of the transactions, and creditworthiness of the client’s customers.

Is Factoring a recent financing option?

Factoring has been around for centuries. It’s one of the oldest types of financing, first seen in the United States in the garment and textile industries. Today however, Factoring is a funding solution for companies of all sizes, from small businesses to Fortune 500 companies, and in all industries.

Is Factoring a type of loan?

No. Factoring is not a loan, it does not appear on the balance sheet as a liability. It is the purchase of accounts receivables as an asset. While approval of a bank loan considers all of your company’s assets as well as your financial history and balance sheet; a factor relies mainly on the credit worthiness of your customers. Factoring is often the ideal solution for start-up businesses, those experiencing fast growth, businesses with poor financial histories, or weak balance sheets. It is quicker and more straight forward than a bank loan.

Why would a business sell its accounts receivable?

Businesses with cash flow shortages cannot wait 30, 45 or even 60 days or longer for payment on their invoices. They need immediate cash to grow their businesses, take advantage of supplier discounts, improve their credit rating, as well as to meet all their other financial obligations.

Who makes a good Factoring client?

Companies who sell a completed products or services to commercial or government entities and need cash fast to meet rapid growth, make payroll, payroll taxes, pay suppliers, to take supplier discounts, buy equipment or fulfill other financial obligations make excellent factoring clients.

As is frequently the case, as much as 80% of a company’s business can come from 20% of its customers, so these would be the most likely receivables to factor. However, factors can finance 100% of your credit worthy customer base if a company chooses.

What types of businesses use a Factoring company?

Companies from a broad range of industries include, but are not limited to: distributors, telecommunications companies, temporary staffing agencies, transportation/freight companies, service providers, manufacturers, wholesalers, consulting companies, and security guard services.

In addition, when you Factor your accounts receivable, your company incurs no debt, as there is no interest to pay or principal to repay. Factoring can also help companies that banks traditionally shy away from, such as start-ups, companies with tax liens, or even companies in bankruptcy.

Are all business transactions eligible for Factoring?

Those transactions that are not eligible are:

How does Factoring differ from bank financing?

decisions based primarily on the creditworthiness of a firm’s customers, while a bank’s credit decisions rely mainly on a company’s financial history and financial documents, cash flow, and collateral. Factors fund quickly, often within a one to four days of receiving an application and accompanying documents; banks on the other hand generally take weeks or months.

In addition, when you Factor your accounts receivable, the cash injection does not appear as a liability on the balance sheet. There is no interest to pay or principal to repay. Factoring can also help companies that banks traditionally shy away from, such as start-ups; companies with tax liens, but those with a payment plan in place; or even companies in bankruptcy (Debtor-in-Possession).

Will I be locked into a long-term client agreement with a Factor?

Though most factors have client agreements, they can vary in duration, from a month-to-month basis to agreements that are for 3 months, 6 months, or even 12 months. It is more common to have a 6-month to 12-month agreement. A business considering a factoring arrangement should closely examine which duration of an agreement best suits their business situation.

Most contracts can be terminated with written notice. But be aware that early termination of an agreement may carry with it certain penalties. It is not recommended that any company sign an agreement with a term of longer than 12 months.

What type of invoices can my business Factor?

You can Factor almost any valid invoice for a service or a product that has been delivered to and accepted by your creditworthy commercial customer or government vendor.

How much does factoring cost?

Discount fees, or the rates charged by a factor for the funds they provide, are based in part on the creditworthiness of a client’s customers, the monthly volume of all invoices submitted to a factor, and how long it takes a client’s customers to pay the invoice. Rates vary among factors and are based in part on these criteria. Depending on a company’s circumstances, discount rates can range between .7% and 4% of the face value of all invoices submitted.

Why shouldn’t I just offer a discount to my customers for early payment?

The factor’s discount fee is similar to an early payment discount, akin to what you might offer a customer. For example, let’s say you provided a service to a customer and sent them an invoice due net 30 days. Let’s also say that your customer offered to pay you cash immediately rather than forcing you to wait the 30 days. Would you take the cash less, say, a 2% or 3% discount you offered for early payment, you probably would.

However, as you well know just because the terms are net 30 days doesn’t necessarily mean that you will get your money in 30 days; you may end up waiting more than 30 days to collect. Whatever the terms, you have just given your customer an interest free loan. Why not be assured of immediate payment by factoring your receivables for about the same cost? Why not have the use of your money now rather than later, in some cases much later?

Can factoring discount fees end up being less than some other financing arrangements?

Oftentimes, funds from factoring allow you to take advantage of your suppliers’ discounts for early payment. Under these circumstances, you get immediate access to your money at rates that can be better than many other financing arrangements. For example, bank loans, especially when you take into account the closing costs, origination fees, and additional points that may be tacked on can turn out to be more than factoring.

Does a discount fee of 3% or 4% mean that my rate is 36% or 48% per year?

Absolutely not! This is a common misunderstanding; a client should not annualize the factoring fee or discount fee. Remember, you are not borrowing money with an interest rate, but rather paying a single financing or discount fee. For example, a discount fee of 3% for 30 days is a single one-time rate for submitted invoices. If terms are net 45, the actual rate could be a single one-time fee of 4% for 45 days. So the fees in the above examples are not 36% or 48%, but rather 3% or 4% depending on the invoice terms. The key here is not to annualize the discount fees; discount rates are for a specific period of time, say, 30 or 45 days, not a year.

What are advance rates and how much cash can a company receive from Factoring?

Many Factors can advance often within 24 to 48 hours up to 90% of submitted receivables. The advance rate, say, 85% or 90%, is the percentage of the face value of the invoices submitted that is made available to clients. The balance (less the discount fee) is released to the client upon payment of a company’s invoices to the factor.

How long before a company receives funding?

Frequently, funding can take place within one to 4 four business days of receipt and acceptance of clients’ applications and accompanying documents.

What can a business do with the additional cash it obtains from factoring its accounts receivable?

Clients can use the cash to meet payroll and payroll taxes, pay suppliers, take advantage of supplier discounts, purchase inventory or equipment, or take on more orders.

Does a business need to Factor all of their invoices?

No. Depending on the amount of additional cash a business owner requires, they decide which of their invoices they want to submit to a Factor.

Can a factor purchase only a portion of a company’s invoices or only one customer?

Generally yes, but it should not be a one-time financing arrangement.

Which companies benefit the most from factoring their invoices?

Factoring is a good fit for many companies for a variety of reasons. Start-ups and high-growth businesses need cash from factoring to help fuel their growth. Companies who have suppliers to pay or service-based companies with high payroll and payroll taxes use factoring to assure they can meet their financial obligations.

How does Factoring affect a company’s customers?

Basically, factoring will require a change in the address to which payments are mailed. In addition, factors handle collections for businesses, allowing them time to manage their core business. Otherwise, working relationships between a company and its customers will remain the same.

Will a company’s customers think that it is experiencing financial difficulty when they learn that it’s using a Factor?

No, not necessarily. Factoring is a long-established and mainstream financing option for businesses. Many times, businesses factor their receivables to fuel rapid growth. It is also likely that some of a business’ own customers do business with vendors also using a factoring service. It is a financing arrangement used by small businesses as well as Fortune 500 companies.

What should a client tell their customers when they begin factoring their accounts receivable?

Should a factoring client’s customer question a notice of assignment and inquire about it, the client need only to tell them that they have chosen to use a company to manage and finance their accounts receivable.

Who will be responsible for collecting from account debtors?

Factored invoices are stamped with the factors address to which payments are to be sent. This is done before invoices are mailed to your customers. Furthermore, factors generally have many years of experience handling collections and do so with expertise and finesse. Factors’ collection services allow companies the freedom to concentrate on growing their businesses. Throughout the process, the factor stays in contact with the client and asks for its involvement when necessary.

What should a client do if a customer mistakenly sends the invoice payment to them?

The answer to this question will generally apply to most factors you deal with. This can happen especially with the first initial funding. If this occurs, the check must be sent immediately to the factor. A client should never deposit invoice payments that were already purchased by a factoring company. A client’s customer should be notified to make future payments directly to the factor.

My company owes back taxes; can I still apply for accounts receivable financing?

Tax issues are handled on a case-by-case basis. Inform the factor of your tax situation at the outset of the arrangement. They will need to discuss a lien subordination with the tax entity and ensure a payment plan is in place.

Will my company be eligible for accounts receivable funding if it has a bank loan or line of credit?

If a bank has a lien on your company’s accounts receivable, you should immediately advise the factor of this situation. A factor will ask the bank to subordinate the lien. Many banks will subordinate, but this is handled on a case-by-case basis. Many factoring referrals come from loan officers willing to help out a client with cash flow needs.

If my company is considering bankruptcy, is accounts receivable funding still an option?

Generally, Chapter 11 is the only form of bankruptcy that a factor will consider, but such circumstances are handled on a case-by-case basis by the factor.

Does it matter if a company has a bankruptcy, bad credit, poor financials, or other derogatory information?

Financing decisions are based primarily on the credit worthiness of a firm’s customer base; the financial strength of your company is generally not a determining factor for obtaining factoring services. A factor will make such decisions on a case-by-case basis.

What information do Factors require?

Informational requirements may vary among Factors, especially depending on your industry. Some of the documents a factor may request are: a short application, your company's most recent accounts receivable and accounts payable aging reports, articles of Incorporation or d/b/a filing, a master customer list and a sample invoice.

For industries such as the trucking/transportation industry, additional information may include: original bills of lading, insurance information, ICC authority. For staffing companies additional documents may include: insurance confirmation, signed time sheets, weekly or bi-monthly invoices that match submitted time sheets, rate confirmation agreement.

Why do Factors require so much confidential business financial information?

The burden of risk is on the factor that provides a business with cash in exchange for only the paper receivables given to them. When a factor has a thorough understanding of a company’s business situation, they will be able to provide an appropriate and responsive fee and cash advance structure.

What collateral does a Factor require to finance my receivables?

A Factor, unlike a bank, does not require a business to put up all its assets as collateral. Generally, a full-recourse factoring agreement will require all invoices as collateral as well as inventory related to those invoices.

Why must all receivables be pledged as collateral on the UCC-1, when only a portion of all of a client’s receivables are actually Factored?

A helpful way to look at this is when a borrower pledges their house as collateral for a mortgage, they can’t pledge just the top floor or just the garage; they must pledge the entire house. Similarly, accounts receivable is one class of collateral and can’t be divided. There is no collateral value in having recourse only to the nonperforming receivables. So, a factor must have first position on all accounts receivable while you are factoring.

I have customers all over the United States. Are there any restrictions?

No. Factoring can work with any business or government agency in the U.S. or in a foreign country. What matters is that your customers are creditworthy.