Selling Accounts Receivable Can Improve Cash Flow

Factoring is a type of financing which improves cash flow and has significantly increased in popularity for small businesses. Factoring is the sale of your accounts receivables (AR) to a funding source at a discount from the face value in return for immediate cash. Companies that purchase accounts receivable base approval on your customer’s ability to pay, not yours.

What is the Process in Factoring Invoices?

The process typically works like this: you provide products and services to your customer and issue an invoice. Without factoring, you wait 30-60 days for payment. With factoring, the factor immediately purchases the invoice and advances an initial fee of approximately 90% of the invoiced amount. In most cases, you’ll have funds in your account within 24 hours. When your customer pays the invoice (directly to the factor), you’ll receive the remaining balance less the factor’s fee.

What is the History of Factoring in Business Financing?

Purchase order financing and factoring are well-established forms of business financing. Factoring produces immediate cash payments at the time of shipment, delivery, and invoicing a customer. Americans have been using factoring since colonial times. Its origins date back even further, 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 1.8 billion credit cards in circulation, 3.75 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 $15,950. Millions of times throughout the 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. Without it, the national economy would severely suffer.

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What are the Benefits of Factoring for Your Business?

In this simple transaction, the issuing bank or card company is the factor – using Visa, MasterCard, or other systems and advancing the seller of merchandise or service immediate cash after your purchase, long before you pay. The seller gets cash upfront without having to wait for your payment. That way, 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, the discount is 2-4% of the purchase price. Thus, for every $100 of merchandise you buy with a credit card, the seller gets $96 or $98 cash immediately.

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. Credit extension is usually 30 or 60 days. You become his lender and him your borrower. To reach the length of time credit, you lose the value of the tied-up money because you can only anticipate payment. If Mr.Smith had paid cash, you could have invested that money immediately. You also earn interest on it rather than having to wait. When Mr.Smith pays late, your cost increases further still.

There is no “free lunch” in business; someone has to pay the costs of your extension of credit. Either you pay for lesser profits or your other customers have no other choice but to pay higher prices. In a limited company, excessive credit extension and late customer receivables can spell disaster.

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