Factoring - Raising Money Without a Loan

Does your business have an opportunity to expand, but you don't have the money to invest in additional production materials? Is your business going through a down cycle, and need money to make payroll and pay other expenses? Do you need money for your business but have already borrowed money? If you have answered yes to any of these questions, you may want to consider factoring as an alternative form of raising money.

What is factoring?
Factoring is a legal agreement between a business owner and a financial institution. The financial institution (factor) advances the business owner money against proceeds from the business owner's outstanding accounts receivables.

How does factoring work?
In the course of doing business, a business owner sells goods and services to its customers. Many of these customers do not pay the business owner immediately. These customers are invoiced by the business owner, and the customers are expected to pay the business owner within a specified period of time (typically 30 days). The accounting term for these outstanding obligations is Accounts Receivable (AR). Since the AR of a business are legal obligations of its customers to pay the business owner, the AR of a company is viewed as an asset. The problem with AR is that the business owner has to wait for its customers to pay their invoices, which can take 30-60 days, in many cases longer.

This is where factoring comes in.
There are many financial institutions (which in most cases will not be your local bank) that are eager to advance business owners money in exchange for the rights to collect their AR. Once an agreement is made between the business owner and the funding source, the business owner will receive a large percentage of his/her outstanding invoices in 24-48 hours. With factoring, a business does not have to wait 30-90 days for its customers to pay.

How are business invoices collected under a factoring arrangement?
The business owner sends out the invoices to its customers, with instructions to remit payment to the funding source/factor. The funding source will perform all collections functions of the invoices, including record keeping and handling slow paying customers.

How much does factoring cost?
Factoring is not a loan, so you do not have to pay back the money that the funding source advances you. As the funding source collects payments for your invoices, it witholds a percentage for itself for credit management fees and interest charges (which are agreed to in writing with the business owner) and sends the remaining percentage of the invoice to the business owner. The cost of the management fees and interest is usually less than the Prime interest rate at many banks. If the factoring agreement has a recourse clause, the business owner has to repay portions of the advance back to the funding source to cover any invoices not paid by the business owner's customers. If the factoring agreement has a non-recourse clause, the funding source bears all risk in collections.