What is debt factoring? A lot of business owners have heard about it but they don’t really understand what it is and how it works. You’ll see a lot of blogs and marketing agents say that debt factoring is one of the best ways for a small business to establish steady cash flow and a working capital.
Defining Debt Factoring
Debt factoring is also referred to as accounts receivable financing, invoice factoring, or the act of selling receivables. It is not exactly a loan because you don’t have to pay anything after you get the money. Here’s a basic rundown of how it works.
Say for example, Company A has an invoice worth $10,000, which their customer will pay in 60 days. Now they can sell their accounts receivables to Company B which is referred to as a factor. The factor will review the invoice and the credibility of the customer – not Company A – and if approved, they will buy the face value of the invoice at a discounted price. Company A agrees and, for the sake of this example, gets $9,000. 60 days later the factor will be the one to collect the actual $10,000 and get a small fee in return.
Why Go for Debt Factoring?
So why go for debt factoring? First of all it is a lot easier to deal with than a bank. A bank will look into the business’ credit rating and their sales for the past two years. Often approval can take two weeks or more and the payment plan (especially the interest rates) can be ridiculously high. None of these becomes an issue with debt factoring or invoice factoring.
Factoring companies won’t look into your business’ credit history because they will instead look into your customer’s credit history. After all, the amount will be coming from your customer. Another thing is that factoring companies can assess and deposit the amount in as quickly as two days. This is very fast when compared to the time it takes a bank to approve you for a loan. Since it is not a loan, you do not have to worry about suddenly paying the amount back. The only drawback is that you don’t get 100% of your intended accounts receivables. On average, you’ll get 80% which isn’t entirely too shabby. Putting everything together you’re getting instant cash that can re-establish your working capital and put cash-flow back into your business.
What if the Customer Doesn’t Pay?
One main concern is on what would happen should the customer not pay or fulfill the invoice. For most cases this is no longer the concern of the company because collecting responsibilities and the risks will now fall onto the shoulders of the factoring company. There is a type of factoring, known as recourse factoring, where the company will be responsible for collecting. This is to keep the agreement between the company and the factor discreet because sometimes customers may not like to deal with businesses that rely on factors.
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