Factoring is one of the solutions that companies can turn to when they suddenly need to free up their cash flow. To understand how factoring works, we first need to look at one of your company’s most important assets: Accounts Receivable. When you have a lot of receivables, this means that you already have sales but you don’t have the cash yet. You already sold your inventory, spent for the operating expenses, but your client is not yet obliged to give you cash for the time being.
What this does is that it drains you of working capital. You have no cash to spend for other expenses because you’re still waiting for your client to pay you.
When you turn to factoring as a solution, you’re selling your Accounts Receivable to a factor or a third party. The ‘factor’ usually advances a percentage (70% – 90%) of the receivables and this solves your problem of cash flow.
By selling your receivables, you now have cash to use for other aspects of your business. This also effectively transfers the risk of these receivables to the third party. The ‘factor’ will be the one to ensure that these receivables are collected, so any risk of your clients not paying is effectively transferred to them as well.
Once the ‘factor’ collects the entire amount, you also get paid the rest of the amount you were originally owed, minus transaction fees taken by the ‘factor.’
Factoring is a common practice especially with companies that have overseas transactions. It’s also one of the most effective ways of getting additional cash flow.
- Spot Factoring – You get to choose which of your receivables you sell. If you’re not comfortable selling all of your invoices, this is the option for you.
- Export Factoring – This is a solution for exporters, allowing them to cater to international customers without having to wait so long for the payment and without having to deal with the many challenges associated with overseas transactions.
- Freight Bill Factoring – If you’re a transportation company, you can make use of your freight bills and get additional cash even before the goods are completely delivered.
- Construction Factoring – Contractors and those in the construction industry know that it takes time for a project to be completed, so with this solution, you get the cash needed to start on your next construction project without having to wait for the current one to be completed.
- 5. Government Receivables Factoring – It’s exciting to win a contract from a government agency, but the problem is that such agencies usually take time to pay their dues. Also, a project with the government takes time to get paid. What you can do is sell your government invoices to a ‘factor,’ and this will give you cash flow without having to wait for, and rely on, the timelines of the government agency you are working with.