What is a Factoring Company?

Summary: A factoring company provides financing to companies that have cash flow problems due to slow-paying invoices. Factors purchase accounts receivable from their clients at a small discount. The client gets immediate funds from the sale of their receivables, which solves their financial problems. The factor, who now holds the receivables, waits until the invoices get paid on their usual terms.

Most factoring lines don’t work like loans and are much easier to obtain. Financing lines are used by small to midsize companies that need to improve their cash position. This article covers the following:

  1. Industries that use factoring
  2. How does factoring work?
  3. How much does factoring cost?
  4. Recourse vs. non-recourse factoring
  5. Advantages of working with a factoring company
  6. Is factoring right for my business?
  7. How to select a factoring company
  8. How to compare factoring proposals

1. Industries that use factoring

Factoring can be used in any industry where goods or services are sold to commercial clients and are paid for in net-30- to net-60-day terms. The following businesses and industries regularly use factoring:

2. How does factoring work?

Factoring transactions are straightforward and easy to use. In most cases, the factoring company buys the receivable in two installment payments.

The first installment is called the advance and is funded when the factor buys the invoices. The advance usually covers 80% to 90% of the invoice. Advances vary based on the risk profile of the transaction.

The remaining 10% to 20% of the invoice, less a small factoring fee, is advanced as a second installment once the end client pays the invoice in full. This payment settles the transaction.

Some industries, such as trucking and staffing, often qualify for higher-than-average advances. In some cases, these transactions can be done with a single installment advance as high as 98%.

To learn more, read “How Does Factoring Work?

3. How much does factoring cost?

The cost of factoring is determined by your financing volume and the credit quality of your invoices. In general, fees range from 1.15% to 3.5% per month.

Fees can be structured to suit your needs. Some situations call for flat-fee structures, while others use a pro-rated model. Fees can be negotiated with the factoring company and vary by client. Sample fees include:

  • 1% per 10 days (3% per month)
  • 0.5% per 10 days (1.5% per month)
  • 2% per 45 days, 0.5 % per 15 days thereafter

4. The difference between recourse and non-recourse

Factoring companies usually offer one of two types of factoring: recourse and non-recourse. Unfortunately, the subject of “recourse” is one of the most misunderstood concepts in the industry.

In a recourse factoring plan, your company is always responsible if your client does not pay. After 90 days, the factoring company can present an unpaid invoice to you for reimbursement.

In a non-recourse plan, you don’t have to repay the factor if the client does not pay due to bankruptcy. However, the bankruptcy usually needs to happen during the first 90 days that the invoice is outstanding. Bankruptcies after this 90-day period are often not covered. This important detail is often overlooked by clients.

Note that non-recourse factoring does not protect you against late client payments. Invoices that remain unpaid after 90 days are still returned to you for reimbursement, regardless of recourse.

Non-recourse factoring is not necessarily better for your company. While non-recourse offers some protection against client bankruptcies, it comes at a price. Non-recourse plans tend to be more expensive and restrictive.

5. Advantages of working with a factoring company

The main advantage of working with a factor is that your cash flow improves immediately. You don’t need to have money tied up in slow-paying accounts receivable. Instead, you have cash-at-hand to pay expenses and take on new clients.

Additionally, factoring providers can also offer other benefits such as:

  1. Assistance with business credit decisions
  2. Support handling collections
  3. Flexible lines that increase quickly
  4. Easy qualification requirements

6. Is a factoring company right for me?

Usually, factoring financing helps your business if the following are true:

  1. Your commercial/government clients pay in net-30 to net-60 days
  2. Your commercial clients have good credit, and
  3. Slow payments are causing cash flow problems

If items 1-3 apply to your company, financing your invoices can improve your cash flow.

7. How to select a factoring company

Selecting the right factoring company is important to the success of your business. Consider the following six questions as you interview factors:

a. Do they specialize in your industry?

Most factoring companies describe themselves as generalists. While this claim is true, most factors have industry preferences. When possible, work with factoring companies that have clients in your industry. This strategy ensures they are familiar with your client base, general credit, and payment habits.

b. Are their advances and rates competitive?

The industry is so competitive that differences in price between factors tend to be small. Do some research and determine what a competitive rate is for a company in your industry. Also, be careful of companies with very cheap factoring rates. Those plans tend to have hidden fees and terms that boost the factor’s earnings. It’s best to work with a factor that is transparent and upfront about fees.

c. Do they have minimums?

Many factoring companies give you better pricing if you guarantee a minimum invoice volume. The usefulness of minimums depends on your situation.

Minimums can cause problems for small companies or companies with unpredictable cash flow. However, minimums can also provide you with negotiating power, as you can get better terms.

In most cases, minimums can be negotiated. Most companies offer plans with no minimums.

d. How quickly can they set up your account?

Most factoring companies can set up an account in three to five days. The main issues affecting the length of the setup process are:

e. Can they provide references?

It is a good practice to ask your factor to provide you with client references in your industry (we can). References can help you determine if clients are a good fit for you.

f. How long have they been in business?

Lastly, look at how long your factoring company has been in business. It is to your advantage to work with a company that has been in business for a long time. Remember that you will be relying on them for cash flow.

Get detailed information regarding how to select the best factoring company for your business.

8. How to compare factoring proposals

Comparing factoring proposals isn’t always easy since there are no standard factoring terms. Most proposals include the following components:

  1. Factoring rate
  2. Advance
  3. Ancillary fees (if any)

The easiest way to compare proposals is to look at the cost per financed dollar. To determine this cost, divide the rate by the advance. The result gives you the cost per financed dollar in cents for each proposal. Learn how to compare factoring rates/proposals.

Are you looking for a factoring company?

We are a leading factoring provider and can offer low rates and high advances. For more information, get an online quote or call us toll-free at (877) 300 3258.