We all know that banks do not offer a friendly credit environment for small businesses. If they offer money, it’s usually not enough. A loan often leads to slow growth of your business due to lack of funds. However, there is a type of financing that is increasing significantly in popularity in our industry. It’s called factoring.
What is Factoring?
Factoring is a type of financing that focuses on your client’s ability to pay, not yours.
Factoring is the sale of your accounts receivable (invoices) to a financing source with a discount of the nominal value in exchange for immediate cash. The source of financing is a factoring company.
The process usually works like this: Provides products and services to your customer and issues an invoice. Without factoring, you wait 30-60 days for payment. With factoring, the factor immediately buys the invoice and advances an initial payment of approximately 92% of the invoiced amount. In most cases, you will have funds in your account within 24 hours. When your customer pays the invoice (the payment is made directly to the factor), you will receive the remaining balance minus the factor charge.
Factoring and financing of purchase orders are well-established forms of business financing that produce immediate cash payments at the time of delivery, delivery and billing of a customer. In its basic form, factoring has been used by American businesses since the colonial era, and its origins go back even further, thousands of years to the first days of commerce.
American consumers take part in a common form of factoring every time they use a credit card. There are 1.8 billion credit cards in circulation, 3.75 each for every American cardholder. In 1970, the average balance of individual cards was $ 649, increasing in 1986 to $ 1,472, and today it is $ 15,950. Millions of times throughout the day, every company that offers customers the privileges of charging by credit cards is the direct beneficiary of factoring. The American retail business depends on the factoring system, and without it the national economy would be severely disabled.
In this family transaction, the issuing bank or the card company is the factor used by Visa, MasterCard or other systems. Advance the seller of the merchandise or the immediate cash of the service after your purchase, long before you pay. Because the seller receives cash in advance without having to wait for payment, your money is not tied up in accounts receivable. For the double privilege of making credit available to customers and getting an immediate payment, the company is willing to pay a discount to the issuing bank or the credit card company – usually 2-4% of the purchase price. Therefore, for every $ 100 of merchandise you buy with a credit card, the seller gets $ 96 or $ 98 in cash immediately.
Factoring does the same for commercial or business-to-business transactions
When credit is given to a client, he or she is essentially becoming a part-time banker for that client. For the credit period extends to Smith Customer – 30 or 60 days – you become your lender, and he your borrower. For the time the credit is extended, the value of the money tied is lost because payment can only be anticipated. If Mr. Smith had paid in cash, he could have invested that money immediately, gaining interest in it instead of having to wait. When Mr. Smith pays late, his cost increases even more.
There is no “free lunch” in business, someone has to pay the costs of their credit extension. Either you pay for the reduced benefits or your other clients are forced to pay higher prices. In a marginal company, the excessive extension of credit and late receivables from customers can spell disaster.