We all know that the banks do not provide a friendly credit environment to the commercial cleaning industry. If they offer any money, it usually isn’t enough. This often leads to an inability to grow your company due to a lack of funds. Well, there’s a type of financing out there that is greatly increasing in popularity in the janitorial industry. It’s called factoring. This type of financing concentrates on your customer’s ability to pay, not yours.
Factoring is the sale of your accounts receivable (invoices) to a funding source at a discount off the face value in return for immediate cash. The funding source is known as a factor.
The process typically works like this: Your cleaning company provide services and issue an invoice to your customer. Without factoring, you wait 30-60 days for payment. With factoring, the factor immediately purchases the invoice and advances an initial payment of approximately 80% of the invoiced amount. In most cases, you’ll have funds in your account within 24 hours. When your customer pays the invoice (payment is made directly to the factor), you’ll receive the remaining balance less the factor’s fee.
Factoring is a well-established form of business financing that produces immediate cash payments to a company at the time of shipment, delivery and invoicing a customer. In its basic form, factoring has been used by American business since Colonial times, and its origins go back even further, literally thousands of years to the early days of commerce.
American consumers take part in a common form of factoring every time they use a credit card. There are 1.4 billion credit cards in circulation, 2.6 each for every American cardholder. In 1970 the average balance on individual cards was $649, increasing in 1986 to $1,472, and today it is an astounding $16,061! Millions of times a day every business that offers customers charge privileges using credit cards is the direct beneficiary of factoring. American retail business depends on the factoring system, and without it, the national economy would be seriously handicapped.
In this familiar transaction, the issuing bank or card company is the factor-using the Visa, MasterCard or other system-advancing the seller of merchandise or service cash immediately after your purchase, long before you actually pay. Because the seller gets cash up front without having to wait for your payment, his money is not tied up in receivables. For the double privilege of making credit available to customers and getting immediate payment, the business is willing to pay a discount to the issuing bank or credit card company-typically two to four percent of the purchase price. Thus for ever $100 of merchandise you buy with a credit card, the seller gets $96 or $98 in immediate cash.
Factoring accomplishes the same for commercial or business-to-business transactions. When you extend credit to a customer, you are essentially becoming that customer’s part-time banker. For the period credit is extended to Customer Smith – 30 or 60 days – you become his lender, and he your borrower. For the length of time credit is extended you lose the value of that tied-up money because you can only anticipate payment. If Mr. Smith had paid cash, you could have invested that money immediately, earning interest on it rather than having to wait. When Smith pays late, your cost increases still further.
Since there is no “free lunch” in business, someone has to pay the costs of your extension of credit; either you pay by reduced profits, or your other customers are forced to pay higher prices. In a marginal company, excessive credit extension and late customer receivables can spell disaster.