Understanding Factoring is not brain surgery

The past couple of years have been challenging for the retail sector as consumer confidence declined and consumers cut back on their spending. When there is uncertainty in retail, like when a major retailer goes bankrupt, there tends to be an uptick in demand for factoring.

Factoring is a form of credit protection against a customer’s financial inability to pay. It refers to an agreement between a factor and a company that supplies goods, typically to the retail industry, in which the factor purchases the accounts receivable from the supplier and assumes responsibility for a retailer’s financial inability to pay.

Factoring plays a vital role in trade flows; factoring enables suppliers to look to their factor to protect them against bad debt losses. In the event a retailer becomes insolvent, or financially unable to pay, the factor will pay the supplier for the full undisputed amount due on all credit approved accounts receivable.

Factoring is also attractive for the liquidity it may afford a company. Many suppliers borrow against the value of their accounts receivable, so factoring enables a supplier’s financing to grow as its receivables grow. Factoring, is simply a method used by many businesses, large and small, to convert sales on credit for immediate cash.

Keep this in mind. The use of a factoring is a type of cash advance for a business. Timing of client payments is not a concern and the cash advance is paid back (plus fees and interest charged) when the invoice is paid (businesses that may use this type of financing should have minimum profit margins of 15 percent).

What types of businesses can benefit from factoring?

Rapidly growing
Concerned about adding fixed costs
Have a lengthy manufacturing cycle
Strained by slow turnover of receivables
Hurt by high bad debt losses
Concerned about a large customer concentration

What does it cost?

There are two costs associated with factoring: the factoring commission and the interest charged on advances against receivables.

The interest rate is competitive with short-term working capital bank facilities. It is charged monthly or quarterly, at a rate tied to the base lending rate of the factoring company with the addition of a margin and is calculated on the average daily amount advanced during the month or quarter.

The factoring commission is quoted as a percentage of factored volume and is based upon (1) factored sales volume (2) average invoice size (3) terms of sale and (4) number and type of buyers.

How does factoring work?

The factor

Pre-approves lines of credit by buyer
Approves credit and shipment requests electronically
Provides credit protection on all approved orders

The seller

Ships goods to buyer
Sells and assigns the invoice to factor
Sends the original invoice to buyer (with the notice ‘payable to factor’)

The factor

Ledgers the invoice
Maintains buyer payment records
Maintains and adjusts balances
Provides cash advances to seller prior to collection (as needed)
Collects payment on open balances
Identifies buyer objections to payment
Follows up on overdue receivables
Electronically applies cash payments
Marks invoices as paid
Records detailed transaction information
Applies collected funds toward advances provided to seller
Forwards balance to seller (if needed)
Complies and forwards dispute and deduction information to seller

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