WHAT IS FINANCE FACTORING?
Finance Factoring is a financial transaction in which a business sells its invoices to a factoring company at a discount. It is commonly referred to as invoice factoring or financing, small business factoring, accounts receivable factoring or accounts receivable financing. It is a more of assets based lending, meaning you borrow based on the assets you have.
Businesses sometimes factor their receivable assets to meet present and immediate cash needs during periods of cash flow problems. However, finance factoring is common in industries where small and medium scale enterprises are thriving, because the funding provided helps them to sort out pressing needs like employee payroll, carrying out customer’s orders or expansion of the business. Based on the industry best practices for payment terms, factoring services can be repaid ranging from 15 to 120 days.
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HOW DOES FINANCE FACTORING WORK?
In finance factoring, there are three parties to the agreement. The entity providing the funds called the FACTOR – this entity purchases the assets (money) from the business that needs the funding also called the SELLER, and the client (DEBTOR) who has the financial responsibility to pay the factors invoice amount. The factor issues an invoice to be paid by the debtor to the factor after the business (seller) has gotten funding from the factor. The factor by law has the right to receive payment directly from the debtor for goods and services provided by the seller has shown on the invoice.
The ownership of the assets sold is transferred from the seller to the factor thereby becoming the factor’s asset and therefore can do whatsoever transaction with it without any obligation to the seller. However, depending on how the factor agreement is written, the seller may acts as an agent for the factor and receives payment from the debtor. This arrangement transfers the risk of default on the part of the debtor to the seller. Hence, if the debtor does not fulfill his obligations the seller is billed the unpaid balance by the factor.
For every factoring transaction, the factor keeps the following record as an evidence of transaction:
- The cash advance given to the seller
- The interest to be paid on the advance
- The expenses resulting from bad debt
- The amount held back to cover for goods returned
- Any other fees that may be applicable depending on the factor
The factoring process is in two stages:
Setting up the account – to set up a factoring account takes about 5 working days. Things done during this time include; submitting a list of intended/existing clients, submitting a sample invoice, a report on accounts receivable and a duly completed and signed application form. All submissions will be checked and if approved, then additional details such as bank statements, certificates of incorporation and audited accounts may be required.
However, when setting up an account there are two types of factoring services the first is a confidential system where the clients/debtors are not aware of the finance factoring agreement while the other is an open system where the clients/debtors are informed of the factoring. For the open factoring system, the clients are notified of
- the involvement of a third party and
- the transfer of invoices from the seller to the factor
Funding the account – once the account has been set up, a credit line will be set up with a maximum bench mark from which funds can be accessed. The funding comes as fast as one – two days. And the funding of the account comes in two tranches, the first payment is a lump sum of typically about 85-90% of the advance and the second tranche the remaining 10-15% is paid minus the factors fees when the debtor fulfils the obligation.
FINANCE FACTORING: ADVANTAGES AND DISADVANTAGES
- Advantage: The seller receives money on an invoice in 1-2 days and will be able to continue to take on new jobs by putting the money back to work instead of waiting for 30 days to receive funds.
- Disadvantage: The problem of book keeping can sometimes create unpleasant situations but by embracing finance factoring the time can be a productive resource for growth.
- Advantage: Like alternative business products, finance factoring does not require collateral before it can be obtained.
- Disadvantage: Yielding control of the receivable can be difficult. Not having control of the invoice may lead a debtor to not pay on time. Make sure you find a factoring company that will work with you to collect from the debtor. Understanding the value in the relationship. Also, the seller should only select invoices to be factored for jobs or companies that pay on time so there will be less of a risk of late payment.
- Advantage: The cost to finance factoring is much lower than a working capital loan. At worst case the loan will cost 15% of the invoiced amount where working capital or small business term loans can be as much as 50% of the loan amount.
- Advantage: Depending on the factoring type, either open or confidential, some debtors tend to honor invoices sent to them by the factor earlier. A small business may not have as substantial of reputation as a large funder such as BlueVine. This does not work for all debtors and some may prefer to deal directly with the seller.
- Disadvantage: Some sellers are uncomfortable with a third party payment. They don’t like having a third party collecting on invoices their company generated. The third party may not be as easy to work with on late payments and hurt the relationship the seller has worked to establish.
- Advantage: If a seller is not great or does not like the function of collecting on the debt, factors serve as intermediaries between the seller and the debtor help with collections and resolving those debts.
However, we offer various cash advance services of which finance factoring is one. Kindly visit more of our website: https://www.confirmcapital.com/ for more information.
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