What Are Receivable Factoring Accounts?
Businesses often sell goods and services to customers on credit. This produces invoices called accounts receivable. Often, companies need cash to pay for the day-to-day operations of the business. Receivable factoring involves a financial transaction that allows a company to convert its accounts receivable into immediate cash. The business sells the receivables, at a discount, to another company; this is called a factor. In exchange for the upfront money, the business must assign the accounts receivable to the factor.
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Why Choose Factoring
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Factoring works for just about any type of business that offers a product or service and has accounts receivables. Businesses choose to employ the services of factors to help them meet short-term recurring business expenses. Companies often choose this method of financing because it offers faster payments, consistent cash flow and no worry about collections. Certain factors specialize in one type of industry, such as health care, transportation, construction or manufacturing.
Qualifying
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Factoring provides a company access to working capital to operate the business. Calculate the money the business has in inventory and accounts receivable and subtract the company's own payable. Make a comparison of the two items to determine if factoring makes financial sense. Companies with invoicing that's less than $500,000 a month may fare better using a corporate credit card instead of paying the costs for factoring. Businesses must show a history of growth in accounts receivable in line with industry standards. In addition, firms must have the ability to show their customers' payment history. To get the best rate, factors usually want to see a two-year record of accomplishment. The credit rating of the customers carries more weight than the company's credit rating. Generally, factors prefer businesses with sizable profit margins, such as 30 percent.
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Costs
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Factors often charge an application fee; the amount varies, so it pays to shop around. Pay attention to the discount rate. This rate depend on attributes such as credit profile, the quantity and value of the receivables, the type of industry and the time involved in collecting on the account. Generally, this discount rate runs 1 percent to 5 percent each month. Businesses with excellent credit and large volumes of receivables usually qualify for the 1 percent fee; a 5 percent charge represents the other end of the scale in terms of credit and quantity of the invoices and the risks associated with the industry. This discount fee applies in 30-day increments. The more invoices a business has to factor, the lower the discount rate. Depending on the industry, the factor pays about 80 percent of the face value of an invoice. The business receives the remaining 20 percent, minus the factor's fee, after customers have paid.
The Process
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After the initial application and credit process, the company must meet with the factor to negotiate the rate. After reaching an agreement on the terms, the factor sends the business customers a "Notice of Assignment." This document notifies customers to send payments to the factor. The factor must establish a "lock box" with the business owner; the lock box consists of an account where all customer payments must go to and from which the factor receives its payments. In addition, expect the factor to file a blanket Uniform Commercial Code document, which protects the factor as first lienholder on the invoices made part of the deal.
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References
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