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Factoring Basics
How Factoring Your Accounts Receivable Works
Your business generates an invoice to a credit worthy customer (aka an account debtor). Upon verifying that the invoice is valid, the factoring company advances you a percentage of the face value for the invoice. This is usually 70 -95% depending on the type of industry, credit and payment history of your customer, and the strength of your business. Then you take the cash and put it to work for your business while the factoring company waits for the invoice to be paid. When the invoice gets paid the factoring company takes a fee for their service. The fee is usually 2 - 5% of the face value of the invoice based on the amount of time it takes for the invoice to get paid and a number of other risk factors.
Example of factoring in action:
You sell or provide service to your customer for $100, invoice them and then sell the invoice to the factoring company. The factoring company gives you $75 right away (a 75% advance). When the payment comes in to the factoring company they then take their fee of $2 (2%) and then remit the balance back to you ($23).
Key Concepts To Understand For Factoring To Work:
· Invoices must be for business to business sales
· The invoices must be to credit worthy customers (the factoring company will check this for you and assign credit limits for each customer)
· The goods you are selling or the services you are providing must be finished and complete with nothing left to be done except for the payment to come in
· The advance amount must be enough cash to run your business until the payments are made and you have access to the balance of those payments
· Your gross margins must be large enough to carry the cost of the financing, generally the factoring company looks for a gross margin of 20% or more
· Payments must be made to the factoring company by your customer. This is often done by your customers sending payment to the factoring company's lockbox or in other cases setting up a local lockbox for you that the factoring company has control over
· Your customers will be asked to verify in some manner that the invoices are open, owing and will be paid to the factoring company. This could be via phone, email, faxed letter or some other means. Keep in mind that in some cases you may have to sell your customer on the merits of cooperating with this procedure
Keep in mind that some of the above requirements can be modified based on the nature of the deal. If you own or are starting a business to see how factoring can work for you today!