Factoring How Does It Work?Factoring, how does it work? The factoring process is rather straightforward: first, factoring is easy to set up and terminate; second, to qualify, a business should have no existing primary liens or claims against its accounts receivable; and third, business must have creditworthy clients who pay their invoices promptly and in full. Factoring or invoice discounting involves finding a company that will purchase your invoices or accounts payable at a discount. The amount of that discount will depend upon the length of your invoice payment terms, i.e., 30, 45, 60, 90 days, etc. The discount generally ranges from about 1.5% to 5% for every ten days until payment is due, with the lower discount percentages going to the most creditworthy of the companies that owe you money. Please note: your company's creditworthiness has no bearing on the sale of your accounts receivable; your customer’s creditworthiness is key, not yours. Therefore, with factoring or invoice discounting, you can sell part or all of our creditworthy debt (invoices/accounts receivable). With these points satisfied, the process works like this: 1. Your business contacts a factor to discuss your business’ needs 2. Your business completes a factoring application 3. The factor will review your business’ application; upon acceptance, the factor will accept your proposal 4. Upon your business agreeing with the factor’s proposal, the factor will open an account for you; you are then ready to have your invoices factored. 5. You send the factor a copy of the invoices that you send to your customer. After verifying the invoices, the factor will forward an advance (normally 80-85 %) to your company (usually within 24 hours). 6. After the customer's check comes in, the factor will take out its fee (based on the invoice amount and the length of time the check was out). The remainder of the money (invoice amount minus amount of advance minus factor fee equals remainder) is immediately sent to you. 7. You can factor your invoices for as many months as you need (normally, one to two years or even more). Important points you must remember: with factoring, account receivables owed to the business are used to secure the note. Factoring companies generally charge clients between 1.5- 5% on all invoices they factor. Again, these factoring companies can be a private investor, group of investors, bank or other lending institution. So, when your business enters into a factoring agreement with a factor, your customers will pay the factoring company directly, instead of sending the payments directly to you. In so doing, the factoring company takes responsibility for collecting monies due on the invoices (….and if the factoring agreement is “non recourse”, they are also responsible for any loss stemming from the collection of the invoice debts). It's important to note that invoice factoring is not a loan, so there are no repayments to make once you business has received its advance. In other words, your business simply uses the good credit of its clients to release monies tied up in invoices to be put back into the business much quicker than simply waiting for the clients to pay. This is how factoring works.
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