What is factoring?
Factoring is a form of financing, otherwise known as “accounts receivable financing.” Factoring provides businesses with immediate cash for their invoices, without them having to take out a loan. The factoring firm buys the company’s invoices and then collects on those invoices on the company’s behalf.
The definition of factoring
Factoring is defined as the process whereby a third party buys a company’s invoices at a discount in order for that company to raise capital. The factoring firm advances the company most of the value of the invoice, collects on the invoice on the company’s behalf, and then pays the outstanding balance when the company’s customers have paid in full.
What does a factoring company do?
Factoring is a centuries-old debtor-financing practice that enables companies to enhance their cash flow and expand their business. Some factoring companies take care of all the associated back-office administration as well, with limited paperwork and documentation required from their clients. Unlike a bank, funds are not restricted and grow as your invoices grow. Most factoring companies give you access to the cash you need in as little as 24-hours.
How does factoring work?
Factoring is not the same as a bank loan; you do not incur debt when you sign a factoring agreement and you do not need collateral to secure the cash. Rather, factoring professionals focus on the creditworthiness of your clients and, if they are satisfied with your client’s payment history, the factoring firm pays you up front the majority of the invoice amount. You receive the balance once your client has paid the invoice, minus a small factoring fee.
The Benefits of Factoring Your Invoices
If you deliver goods or services on schedule, but don’t get paid for weeks, how can you keep up with your day-to-day expenses? Do you have a payroll to meet each week, office costs every month, and insurance, taxes, and other overhead expenses? When you factor your invoices, you don’t need to wait 30, 60, or even 90 days for your clients to pay you. You can be paid in advance on those invoices and use that cash for expenses – and have the cushion to grow your business.
Here are a few benefits of factoring your accounts receivable:
• Free up your time
• Improve your financial planning
• Protect your business from debt
• Maintain complete control of your finances
• Keep your collateral or credit history out of the picture
You don’t need to meet a long list of criteria to apply for factoring. Well-established factoring companies don’t require that you have certain types of collateral or that you have been in business for a certain number of years. Your application is reviewed on the basis of your clients’ credit history, rather than your financial background. When you’re looking to raise working capital for your business and are exploring affordable alternatives, consider factoring.
Who uses factoring?Who uses factoring?Factoring helps companies ranging from small business start-ups to large corporations. Businesses in these industries commonly rely on factoring for improved cash flow:• Agriculture• Distribution• Food & Beverage• Government Contracting• Healthcare• Information technology• Manufacturing• Oil & Gas• Service providers• Small business• Staffing agencies• Transportation & Trucking
- Food & Beverage
- Government Contracting
- Information Technology
- Oil & Gas
- Service providers
- Small business
- Staffing agencies
- Transportation & Trucking
Factoring Myth Busters
Factoring services are still widely misunderstood in many industries. We’ve rounded up some of the top factoring myths that need to be debunked.
Myth 1. Companies choose factoring as their last resort
Many thriving companies turn to factoring to access the funds that have been sitting in their accounts receivable for weeks or months. The benefits of upfront payment on their invoices appeal to all business owners, not just companies with financial challenges.
Myth 2. Factoring companies are lenders
Factoring companies are not like banks: they do not lend you money that you must pay back, but pay you for work you have completed. Unlike a bank, factoring allows you to get paid right away what you are owed. You do not have to wait on your customers to pay and you don’t incur debt with loans.
Myth 3. Factoring companies only provide collections services
Factoring companies advance funds on your invoices and help manage your collections. They also add valuable services including payroll management for staffing agencies, invoice preparation, and discount fuel cards for trucking companies.
Myth 4. Factoring companies could change my customer relationships
Your customers will actually reap certain benefits. For instance, when your customers know you are working with a factoring company, they know you will complete your work for them because you will have the working capital to do so. This also enables them to take on more jobs with you as needed.
Bank Loans vs. Factoring
Factoring your accounts receivable is very different from paying off a bank loan because you won’t be incurring debt, you don’t need collateral to apply, and you’re not judged on your credit history. Getting set up with a factoring company is invariably much faster than getting a loan from a bank. Here are some situations in which factoring can be better than borrowing from a bank:
If your business is new: Factoring can be beneficial for almost any type of business, new or old, but start-ups especially benefit. If your business hasn’t built up the equity and credit record that you need to get a loan, then factoring is a good alternative for you.
If you’re waiting too long to get paid by your clients: Whether you’re selling a product to other businesses or government entities or you are selling a service to corporate clients, it’s possible that you’re waiting 30, 60, or even 90 days to get paid. You have monthly expenses that need to be paid and invoice factoring can ensure that you get the money you need without waiting.
If you’re spending too much time on collections and invoicing: As your business starts to grow, you may notice that you can spend a significant amount of time processing invoices and following up on outstanding payments. This is the time that you can use more productively. Whether you’ve hired someone to handle debt collections or you are currently doing this yourself, consider freeing up your time by partnering with a factoring company to take care of the job for you. This is a service that a bank won’t provide you.
If you can take advantage of trade discounts:
You could be able to take advantage of early payment or volume discounts if you have more cash on hand. Instead of borrowing from a bank, factor your invoices so that you pay upfront for purchases and improve your credit score at the same time.
How a Factoring Rate is Calculated
The factoring rate is stated as a discount, usually based on the volume of the invoices you wish to factor. Factoring rates can start at as low as .49% of the invoice amount, and go higher depending on certain variables. Factoring rates are quoted as a percentage of the invoice amount, rather than an annual percentage rate. Since the factoring is not a loan product, and rates are usually fixed, an annual percentage rate cannot be determined when rates are set. Also, unlike an interest rate on a loan, factoring rates include lots of value-added benefits such as back-office credit and collections services, invoicing, delivery of invoices to your customers, and other billing-related services.
What benefits can you expect when you factor your invoice with a top-tier factoring company?
- Receive advances between 95% and 100%
- Fund your business immediately
- Improve your cash flow within days
Generally, the factoring company will pay you up to 100% of your invoice amount, minus the factoring or discount fee. Unlike borrowing from a bank, you incur no debt when you factor. Instead you receive payment upfront for completed work rather than waiting for customers to pay you.
What is a Factoring Agreement?
When you sign up with a factoring company, you will sign a factoring agreement that outlines what you can expect from your factoring company and what they can expect from you. Agreement specifics vary, but all general invoices factoring agreements should outline the process, each party’s responsibilities, and the fees. You can expect the following in a factoring agreement:
- A statement that the client confirms they will “sell, transfer, convey, and assign” selected invoices to the factoring firm
- An agreement that the client will provide accurate and true financial information at all times
- A description of the Notice of Assignment process that tells the client’s customers to send in their payments to the factoring firm rather than to the client
- A commitment for the factoring firm to provide continually updated reports on invoices they have purchased, payments sent and received and other information
- A description of steps taken to secure payment of any indebtedness that is due to the factoring firm in the event of default or insolvency
- A fee schedule that specifies the factoring percentage rate and the advance rate
- A time limit for the agreement
Estimating the Cost of Factoring
If you ask an invoice factoring company to quote factoring rates, be prepared to answer two questions that determine how much you will pay for factoring.
Your factoring rate depends on your factoring volume (how much you plan to factor) and payment terms (how long your customers take to pay their bills).
1. Decide which invoices you’ll factor. Some factoring companies require you to factor all invoices; other companies, like Interstate Capital, allow you to pick the invoices to factor. Typically, the higher the dollar figure you expect to factor, the lower the factoring rate. If your factoring volume is low, your factoring rate could be higher.
2. Estimate your customers’ average days to pay (“DTP”). In some cases, even though your agreed-upon payment terms might be a standard 30 days, some customers may typically take longer and you may need to estimate 40 DTP. If you give your customers extended credit terms, like Net 45 or 60, your average DTP is going to be higher.
For example, imagine that you expect to factor $100,000 per month and your customers pay, on average, in 40 days. If your factoring rate is 2%, your monthly cost of factoring could be $2,000. However, some factoring companies advertise an unusually low factoring rate – and then add on “hidden” fees for services. Look beyond the advertised rate and read the fine print to discover any fees that could increase your actual factoring costs.
4 Signs Saying Your Business Needs Factoring
Read these four tell-tale signs about how this type of business funding could work for you:
1. You have a long list of slow-paying clients
It’s not uncommon to wait 30, 60 or 90 days for clients to pay, but this turnaround time can put a lot of pressure on your business. When you partner with a factoring company, we will advance you a large portion of your invoice within days as soon as your paperwork has been approved.
2. Your business is taking on debt to cover expenses
Bank loans take time and add debt to your business. Merchant cash advances may be fast, but can incur costly fees and high-interest rates that can cut deep into any potential profit margin. Factoring your invoices gives you payment upfront on what you are already owed. You can cover expenses, without incurring debt or paying high borrowing costs.
3. You have customers that require payment flexibility
If you have clients that have long payment cycles, factoring allows you to give them this type of flexibility without affecting your bottom-line or cash flow. This means you can take on new clients and your business.
4. Slow-paying clients are stopping you from growing
Instant access to cash means that you will have the funds you need to invest in your business. Whether you want to be able to negotiate discounted rates with suppliers or hire a new salesperson who will bring in more business, you will often need money to achieve these goals. Factoring companies can put you in the financial position you need to grow.
Choosing the Right Factoring Company
When you’re ready to factor your accounts receivable and enjoy the benefits that come with increased working capital and financial stability, how will you choose your factoring company?
Keep in mind these 5 variables as you make your choice:
The company’s experience in the factoring industry: Older companies tend to have greater stability and proven track records of helping clients succeed. Plus, they have the expertise and experience to develop value-added programs to benefit their clients.Exceptional customer service: Your factoring company should provide you with a single point of contact – an account manager who is friendly, professional and eager to help.
Exceptional customer service: Your factoring company should provide you with a single point of contact – an account manager who is friendly, professional and eager to help.
Ease of managing your account: Leading factoring companies have invested in on-line management systems that make submitting funding requests quick and easy. Find out if you’ll gain the ability to track payments and get a bird’s eye view of your accounts.
The company’s experience in your industry: Different industries work on different business models. Your factoring company should know your industry and offer you tailored solutions for how you work.
Rates and numbers: Ask each factoring company about advance rates, the percentage they charge for each invoice that they factor, and about any additional “hidden” fees.
Six Questions to Ask Before Financing your Invoices
Not all invoice financing companies are the same, with one program and one price. Some factoring companies specialize in niche industries, while others are generalists. Some may offer low rates, but provide little or no client services. It’s worth doing your homework before signing up, to ensure that you know what you’ll get from the partnership and how you’ll interact with the company.
Here are six questions you can ask your potential factoring company:
- What are the fees? Find out if you will be paying a flat factoring rate only or are there other costs involved, like money transfer costs and collection fees?
- What is the length of my contract? A longer term contract may be more beneficial if the invoice financing company can offer you more flexible rates or other benefits. Most companies offer a 12-month contract, but some might be willing to negotiate with you for a shorter contract.
- What other services can you offer me? Some factoring companies will provide a full suite of time-saving and convenient services to handle the back-office work associated with your invoicing.
- How long have you been in business? A well-established factoring company will have years of experience with a wide variety of clients and will have stood the test of time in different business climates.
- Do you understand my industry? Whatever your industry, it’s worth going with a factoring company with professionals who have an in-depth understanding of how your business works.
- Can you offer me flexibility in the number of invoices I will factor? You may not wish to factor all your invoices. You may have different quick pay agreements with some of your customers. Discuss your needs and see if the company will be able to accommodate your requests.
Why Factoring has Become So Popular with Small to Medium-Size Companies
In the past, factoring accounts receivable was a financing option typically reserved for large companies. Today, factoring companies can provide customized factoring services tailored to small and medium-sized businesses. For many of these businesses, turning invoices into immediate cash has become the preferred way to finance their businesses.
The economy has led to slower collection rates: Today, in an era of increased banking restrictions and decreased savings reserves, many small and medium companies struggle to keep up. Instead of endangering payroll or postponing key vendor payments, your company can continue with business as usual while the factoring company pays you upon delivery of your products, shipments, or services.
Small and medium-sized businesses need flexible financing alternatives: Unlike a fixed-limit bank loan or line of credit, factoring provides you with your most flexible funding options without incurring debt. When you factor your invoices, your funding can grow with your business.
Companies can make important purchases: Without a positive cash flow, you aren’t able to invest in critical equipment, vehicles, or other capital purchases that your company needs. With factoring, you can make sure your cash isn’t tied up in aging accounts receivable, an important concern for smaller businesses.
A Real Factoring Success Story
Nearly 20 years ago, four men living in a small community in the Midwest decided to launch their own trucking company. Each of them brought years of trucking industry experience to the new business, which they named Superior Transport. They all shared a vision for a new “family-oriented” company based on friendly customer care, open communications, and good relationships with clients and drivers.
They started by buying four trailers and leasing four tractors. Soon they were ready to expand and they began working with a factoring company. That allowed the business partners to take on shippers with longer payment terms and apply their advances to operating expenses and equipment purchases. Within a few years, they switched to Interstate Capital and their growth accelerated.
Superior Transport was an excellent client, but the day came when the partners were ready to try a different business model. With their good credit history and extensive collateral, they were able to secure a large loan from a local bank. The company was going along smoothly – until business conditions changed. Now burdened with the stress of paying off the debt at the bank while facing decreased revenues, the owners called Interstate Capital for a solution to their cash flow challenges.
Interstate Capital’s upper management welcomed them back warmly. They helped Superior pay off their bank loan and extended them more credit than the bank officers were willing to approve. Now, nearly five years after their return to Interstate Capital, Superior owns around 60 power units and leases on with around 15 owner-operators.
Today Superior’s clients range from household names in the food and beverage industry and building materials field to start-up manufacturers and “mom-and-pop” businesses. Superior now factors an average of $800,000 a month with Interstate Capital and they are still as friendly and easy to work with as ever.
About Interstate Capital
Interstate Capital, one of North America’s largest and best-funded independently owned factoring companies, has successfully funded over 8,000 motor carriers, freight brokers, manufacturers, staffing services, oilfield service companies, and other service businesses since it was founded in 1993. With locations in California, Texas, and New Mexico, Interstate Capital purchases nearly $1 billion dollars of invoices annually from satisfied clients throughout North America.
Our team of 20 dedicated, experienced account managers provides one-on-one client servicing to ensure personalized attention.
As an independent firm still managed by its co-founders, Interstate Capital, can make decisions quickly, decisively and without outside interference. That means clients can be approved and on-boarded promptly and can receive their first advances right away. Interstate Capital is ready to help business owners pursue their financial goals now.