What is a Factoring Agreement?
A factoring agreement is entered into by a factoring firm and a business that wants to sell their accounts receivable at a discount for an immediate cash advance. The customer is also part of the agreement but is not involved in the process because their terms do not change except that they now owe the money to another company. The rate of these agreements will depend not on your business’ credit record like loans but on the credit records of your customers.
Most of these agreements will allow your business to sell your invoices for, usually, somewhere between 70% and 90% of that total sum of the invoices, minus any fees and charges that you may incur in the process. Although you may take a slight financial hit, you would be able to receive an immediate bulk payment rather than wait months for those invoices to be paid off.
Factoring Agreement Basics
Although the general invoices factoring agreement will be just between the factoring firm and your business and the general discount required may be somewhere between 10% and 30%, there are other options available. Reverse factoring is essentially the same process except that three are three parties involved; your business, the factoring firm, and individual customers that have outstanding invoices. Unlike regular invoice factoring where you are dealing with batches of usually random customers, reverse factoring brings individual large accounts into the picture. This allows the factoring firm to ensure that they will be paid and allows your business to receive up to 100% of the total sum due, minus fees and charges.
Other businesses may be able to use their unpaid invoices as collateral to receive loans. Usually used by businesses that are not eligible or in good enough standing to receive a bank loan. These factoring agreements differ in that you do not give up a percentage of the invoice total but have to pay the lender a specific interest rate just as you would to a bank.
Factoring agreements are made between a business and a factoring firm and allow businesses to get immediate cash flow using only their outstanding invoices. This is an increasingly popular way of financing your business without needing to take out a loan or line of credit which can be problematic to obtain. By factoring your invoices at a discount to a specialized firm, you get cold hard cash and are able to continue funding your payroll, business and rental costs, and suppliers.
Factoring is available to just about any business that works with invoices. If you have unpaid invoices and need quick funding for your business, you can factor or â€œsellâ€ the invoices at a discount to a factoring firm. That firm will give you a quick injection of capital giving you the financing you need to pay your employees, manufacturers, suppliers, or any other business cost while they make their money on the difference between the discounted price and the full amount of the invoices. Factoring firms also take care of the collections process, thus making the service even more appealing. Factoring is slightly different from flat out selling your invoices because if the invoices are not paid within a certain time, usually 90 days, you are liable for the unpaid amount.
Invoice factoring is also different from invoice discounting. Discounting is a process in which a business uses its unpaid invoices as collateral for a loan from a non-traditional institution. The business pays only an interest rate on the loan while collecting the full amount of the invoices. The rates for discounting are usually considerably higher than a typical bank loan as well as the rate you would pay through simply factoring your invoices at a discount.
Essentially, factoring agreements allow your business to get the financing you need when you cannot or are unwilling to take out a bank loan or line of credit using only the unpaid invoices you already have.