Companies facing a cash-flow squeeze and slow-paying customers often sell their invoices or accounts receivable to specialized companies called factors. The factor advances most of the invoice amount – usually 70% to 90% – after checking out the credit-worthiness of the billed customer. When the bill is paid, the factor remits the balance, minus a transaction (or factoring) fee.
Companies that use factoring like it because they get money quickly rather than waiting the usual 30 or 60 days for payment. After sending an invoice to a factoring firm, a business can have money in its hands within 24 to 48 hours.
Some businesses use factoring to get started. Whereas banks focus on a business’s creditworthiness in considering whether to make a loan, factors look at the financial soundness of a business’s customers. As a result, firms with scant credit history may be able to sell their invoices.
Billions of dollars in accounts receivable flow through factors each year, many of whom specialize in particular industries such as trucking, construction or health care. Some companies use it to meet cash-flow needs as a stop-gap measure. Others prefer factoring to banks, which often require more paperwork, or other outside investors, who may want a piece of the business.
Since the factoring firm can handle collections, the factor customer can outsource the billing and credit checking functions to the factor. Another advantage: Companies wanting to expand overseas may find factors often already have extensive experience dealing with overseas suppliers or purchasers and so using factors can make international business efforts a lot easier.