For businesses, factoring provides a solution for managing cash flow. Cash flow is the rate at which money enters and leaves the company. Waiting months for a customer to make the payment reduces cash flow, which can prevent a company without major savings from carrying out its activities and meeting its obligations.
Invoice factoringis the way in which a company can secure capital for its creditworthy invoices.
A factor buys a company's invoices and pays the company at an upfront discount. Factoring, one of the oldest forms of business finance, is the cash management tool of choice for many companies. Factoring is very common in certain industries, such as the garment industry, where long accounts receivable are part of the economic cycle. Factoring is a form of financing in which a company sells its receivables to a third party or to a factor company at a reduced price.
Under this agreement, a factor firm undertakes to provide financing and other services to the selling company in exchange for interest and fees on the money it anticipated against the seller's receivables. In this way, companies that need cash can insure about 80 percent of the nominal value of their accounts receivable. Rarely, a higher percentage can be guaranteed, but in most cases 20 percent of the value of accounts receivable is kept in reserve until the accounts are collected. Before starting factoring your company's invoices, it's important to know these associated risks and how you can avoid them.
One of the benefits of using an invoice factoring company is that it allows you to get the cash you need before selling your products. In addition, small business owners must recognize that using a factor company is an all-or-nothing proposition. The balance is paid, minus factoring charges, when the factor is charged to the toaster manufacturer's customer. The growth of factoring suggests that many companies are finding it a cost-effective way to help manage cash flow.
These industries have specifically shown the advantages that factoring their invoices can offer. Small business owners should know that factoring is different in several fundamental aspects of bank financing. Yes, if you compare the factors of the discount rate with the interest rate charged by banks, factoring costs more. In a typical factoring agreement, the customer (you) makes a sale, delivers the product or service, and generates an invoice.
Factoring is a tool used by many established businesses to avoid the types of cash flow problems that arise due to a customer's slow payment patterns. You can receive payment directly after taking into account your bill, even before delivering the project to them. Factoring agreements are a way in which companies with established sales can, for a price, ensure smooth cash flow. Arrangements for charges vary widely, depending on the credit quality of the borrower's customer account balances and the range of services purchased in the factor.