Factoring – A Different Type of Credit
If you run a small business, cash flow is typically one of your biggest concerns. You need to be able to pay the bills, and customers paying their invoices are the primary methods to get cash. However, sometimes, no matter how hard you try, the invoices aren’t paid fast enough to match your cash flow needs. That is where factoring comes into play.
What is Factoring
Factoring is a service where a business sells their accounts receivable (i.e. invoices) to a third party company (called a factor) at a discount to face value. The typical discount is 80-90%, so a company would receive $800 to $900 for a $1,000 invoice.
There are two types of factoring – advance factoring and maturity factoring. With advance factoring, you get the money from the factor in advance of the invoice being paid. In maturity factoring, the factor makes no advance, but rather the purchase price for the batch of invoices is paid on the average maturity date for the accounts. For example, if you have 10 accounts net 30, you would be paid net 30 regardless of what actually happens with the invoices.
How It Can Help Your Cash Flow
Factoring can really help your cash flow because it ensures that you get paid at least a percentage of the invoice, meaning you will have cash on hand. Plus, it is different from a bank loan in that you’re not taking on debt.
Factoring is a financial transaction where a company buys an asset from you. If you remember accounting 101, accounts receivable is considered an asset, and you are simply selling it to another company. With getting a loan, the bank has to analyze all aspects of your business and decide if it even wants to loan you money.
Finally, it can really help your cash flow because, in most cases, the invoice factoring company assumes the credit risk for the invoices. So, if a client doesn’t pay their invoice, you aren’t required to repay the money paid by the factor – instead the factor takes a loss on the transaction. This can really help improve your finances, since you don’t have to worry about non-payment any longer, and instead focus on growing your business.