Factoring receivables provides small and mid sized businesses with many advantages that allow them to succeed in the marketplace. Understanding when you should consider factoring and what the benefits of factoring are is the focus of this article.
Factoring receivables is a process in which a third party factoring company assumes the ownership of the accounts receivable balance and handles the collections on those receivables. As the factoring company assumes the collection risk and incurs the cost of collection they charge a fee for factoring receivables which is typically a certain percentage of the total invoice amount that is being factored. Before a sale is made the factor has to approve either the sale or the vendor, depending on the size of the business and customer. If a sale is not allowed by the factor the company can often still sell to the customer, but as a non-factor sale where the factor does not assume the collection risk. If the customer does not pay, then the factor loses on the transaction but the company is still paid on the sale.
Factoring therefore provides one primary benefit that small and mid sized businesses love. Factoring provides businesses with a reliable cash flow and eliminates a good portion of the business risk that they face from non paying customers. As without a factor a small or mid sized business could potentially go bankrupt as the result of a non paying customer, with factoring that does not really impact them other than the lost future sales.
A second benefit of factoring receivables is that a company can maintain a smaller accounting staff as the collection process has been exported to a third party factoring company. This often frees up resources to deploy in other ways and provides management with the ability to not have to spend time worrying about or improving collections from customers. It is simply one headache that is no longer part of the business model.
In addition, lenders like companies that factor their receivables as they are able to better calculate the ability for the company to repay the bank. If a borrower is particularly risky and still wants a loan, the lender can even set up a feed with many factors so that payments are made from the factor directly to the lender in order to improve the likelihood that the loan will ultimately be paid out. Having this set of more predictable cash flows can lower the cost of borrowing or lead to increased loan amounts that can provide more capital to the business so that they can expand into new markets.
Finally, a company that decides to factor their receivables has a third party check on customers they are considering selling to which helps them to avoid the risk that the customer is dishonest or may be inclined to defraud them. The factoring company conducts research on all borrowers which involves a background check.
Construction Factoring is not beneficial for all companies but a great option for many companies for the reasons outlined above.