One of the chief objections that clients have with using factoring is that their customers need to remit payments to a new address. Actually, notifying the customer of the new payment address and procedure is a standard practice in the industry. Factors use a document commonly known as a notice of assignment. But why is this needed? In this article, we cover:
- Why is a new payment address or bank account needed?
- How do factoring companies collect payments?
- How will customers react to this change?
- Is there a non-notification alternative?
Why is a new payment address or bank account needed?
There is an important difference between invoice factoring and other financing products. Most factoring transactions are not structured as loans. Instead, they are structured as asset sales. The factoring company buys your accounts receivable in exchange for payment. This structure gives factoring companies ownership of the financial rights associated with the invoices they buy.
This transaction creates an interesting situation. Your company delivers the product or service. However, the factor owns the associated payment. Factoring companies want the payment sent to them so that they can settle the transaction directly. It is this feature that makes qualifying for factoring much easier than getting a loan.
To learn more about factoring, read “How Does Factoring Work?”
How do factoring companies collect payments?
Each factoring company uses its own collection methods. Some companies are happy to take over your whole collections process, while others rely on your invoicing and collections process. Factors get involved directly only in spot verifications or when a client does not pay.
The collection process also depends on how your customers pay their invoices. Payments are usually made by check or electronically (e.g., bank deposit or wire transfer).
a) Payments by check
Factoring companies usually receive your customer’s checks through a bank lockbox. A lockbox is a service that allows banks to process check payments and post them to an account the same day that they are received. Many lockbox services also scan all documents received with the remittance and make them available online. As you can imagine, lockbox services help substantially in ensuring factors can settle a payment quickly.
There are three ways to handle the payment information that is printed on the check. Note that not every company offers every option.
i) Payment made in the factoring company’s name
In this situation, your customer has to send the payment to the factor’s lockbox, and checks are made to the finance company’s name. While this method of payment processing works fine, it tends to raise the most concerns among customers. Your customers may feel uncomfortable that their vendor is not listed on the check.
ii) Payment made in the factoring company’s name FBO (“For Benefit of”) client
This is the most common payment processing method in the industry. In this case, your customer still sends a payment to the factor’s lockbox, but the check is payable to the finance company FBO your company. So the check could read: “Some Factor Inc. FBO Client Inc.” FBO is the abbreviation of “For Benefit Of.” This approach makes it clear that, while the check is being sent to the factoring company, the payment is intended to benefit the client’s account.
iii) Payment made in the client’s name
Some finance companies have agreements that allow your customer to send a check made payable to your company, as long as the check is sent to the factor’s lockbox. These agreements are less common in the industry, but some finance companies allow these types of payments. From a client’s perspective, this method is the best because it limits the factor’s visibility in the payment process.
b) Electronic payments
Many clients, especially large companies, send invoice payments electronically. This can be done through the ACH system as a direct deposit. These transactions commonly take a few days to clear. Clients can also send faster payments using a bank wire.
If your clients pay electronically, they must use the factor’s banking information. This includes the factor’s bank name, account number, routing number, and notes about which invoice is being paid. Most customers also send a remittance notice through e-mail (or a similar system) to the factor as well.
How will my customers react to this change?
Clients are often concerned about how their customers will react to this change. This concern is valid since the change is customer-facing. Keep in mind that factors don’t want to interfere in the relationship between you and your customer. Consequently, many factors have developed processes to ensure that payment redirections go smoothly. You should discuss payment processing and notifications with your factor before you start notifying clients. Here are some things to keep in mind.
a) Factoring is very common
Factoring is very common and has been widely used for many decades. Most large companies are familiar with the process because some of their vendors probably use the service. Your customer’s Accounts Payable department is likely familiar with factoring and has a process for it.
b) Reputable factors never harass your customers
Reputable factoring companies always treat your customers respectfully. They should not pester your customers for payments. Discuss this issue with potential factoring partners during your evaluation process. Additionally, ask the factoring company to provide you with client references. For additional details, read “How to Find and Choose a Factoring Company.”
c) Your customers won’t see much change
The impact of factoring on your customers should be minimal. They still get their products/services directly from your company. Additionally, you still handle service and support calls. The only change is that they pay the factoring company. You need to explain this change to your client so that they are comfortable with it.
Is there a non-notification alternative?
Some factors offer a type of non-notification factoring, commonly known as sales ledger financing. These lines closely resemble lines of credit, allowing withdrawals as needed. While the factor still receives payments, your customer gets a simple change of payment address notification rather than a notice of assignment.
However, sales ledger financing is not for everyone. It’s available only to companies that invoice a minimum of $300,000 per month, have some operations track record, and are not in financial distress.
One of the reasons factoring financing is easier to obtain than other alternatives is that your customers pay the factor directly. Handling the payment aspect of collections reduces the factor’s risk and enables them to settle invoices quickly. Most factoring companies have designed their processes to have the least possible impact on your clients. This includes using lockboxes for check payments and handling electronic payments. Lastly, companies that invoice more than $300,000 and are not in financial distress should consider ledger financing, a form of non-notification factoring.
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