A factoring account is a businesses agreement between a company and a factoring agency. Accounts receivable factoring is a form of financing where a business sells its accounts receivable to another company for a percentage of the accounts' value. The company that purchases the accounts is the factoring company, or factor.
Once a company sells its accounts receivable, it receives payment immediately, rather than having to wait for the customer to pay the invoice. The invoice is now controlled by the factor. When the invoice is paid, it is deposited into an account that the factor can draw funds from. Factoring companies usually pay 75 percent to 85 percent of the actual value of the account.
The account that the business has established with the factoring company, remains in effect until the business no longer needs the influx of cash. Factoring is expensive, but it provides the business with cash flow at times when it is needed most. Without factoring many companies would be in financial ruin. The instantaneous cash flow allows companies to pay bills, make payroll and buy materials.
Credit for On-Time Payments
In many cases, a factoring company will rebate a portion of the fee it charges back to the company if the invoice is paid promptly. If the customer adheres to the terms of the sale--such as paying his bill within 30 days--the company will receive a timely-payment bonus. For example, the factor paid 85 percent of the value of the account up front. However, the invoice is paid early, so the factor rebates 5 percent back to the company. The company actually received 90 percent of the face value of that particular account.
Many different industries use factoring. Factoring is very prevalent in the trucking industry. This is a cash-draining business. Repairs, tires, fuel, driver salaries and constant equipment upgrades make the business very volatile. The profit margin is very low and poor cash flow can doom any trucking business. Transportation factoring works on a perpetual system. The receivables are sold daily and the cash is deposited into the account daily. This keeps the cash flowing. Other industries like: manufacturing, distribution and construction all use factoring as a means of financing.
. Another type of factoring account is the account established for bad debt. A factoring company can charge a portion of any bad debt back to a business. This is usually stated in the contract. Debt that is not paid within 120 days is at risk of a partial charge-back. Companies that use factoring companies need to be very credit conscious when it comes to extending credit to any customer or client. These bad accounts can sink a good factoring relationship. If customers exceed an established level of noncollectable accounts, a factoring company will discontinue the relationship with the company.