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Advantages and disadvantages of factoring

Advantages
  • Allows you to seek large contracts if you have the capability to perform them, but not the capital.
  • The factoring company tracks and collects the invoices - you don't have to.
  • Good for cash flow stabilization - you don't have to worry about when invoices are paid.
  • Fast - funding can be done in a few days.
  • You don't have to increase your company's debt levels.
Disadvantages
  • Cost is usually higher than a short-term commercial loan.
  • Usually not a long-term solution.
  • Usually for invoices over $10,000. The payee must be reputable with good credit.
  • Cannot be done if you owe back taxes or have pledged your receivables for other loans.

What is factoring?

Factoring is a method of financing used to fulfill large contracts. Businesses with large contracts need to purchase inventory and make the product (or provide the service) before they are paid, requiring significant capital. Often the business is unable to get lines of credit or loans using its own credit. This is where factoring comes in.

The factoring finance company evaluates the credit worthiness of your customer - not you. If your customer is creditworthy, the finance company purchases your contract and gives you a percentage of the contract's value. You can use this money to purchase inventory and provide the product or service. When you have completed the job, your customer pays the factoring company, the factoring company keeps the amount it paid you plus interest, and pays you any remaining amount.

To use factoring, you must have a purchase order and it should be from a reputable company.

Finding finance companies that factor

In addition to looking on the Internet, you should ask for references from your banker and accountant.

Factoring process

You will need to complete an application, provide your company's most recent accounts receivable and accounts payable aging reports, a master customer list and a sample invoice. You will also need to provide your company's legal formation document (articles of incorporation, articles of organization or dba).

In order to provide you a quote, the factoring company will evaluate your customer list and the age of your accounts receivable.

Once you are approved, your customers will be notified that receivables are handled through them and that payments should be made to them. New invoices should be processed through your factoring company. You will immediately receive a percentage of the invoiced amount (90% is common), with the balance sent to you when the invoice has been paid.

Best Practices

  • Use factoring funds to fund a specific job. Do not use the funds for outstanding bills or other jobs.

Ongoing Responsibilities

  • Provide your factoring company new invoices.
  • Forward any payments received by you to your factoring company.