Factoring, alternatively referred to as accounts receivable factoring, is a business term that refers to the process by which businesses sell their unpaid receivable invoices in order to obtain immediate cash for their operations. When a business sells a product or service, an invoice is generated that details the amount owed and the number of days remaining on the invoice’s payment deadline. This invoice is immediately added to accounts receivable, which refers to money owed to a business. After creating the invoice, it must be sent to the customer and the business must wait the specified amount of time for payment. Oftentimes, due to misfortune or a lack of attention, a debt will remain unpaid and will extend beyond the due date. This creates a problem for the business that is awaiting payment, as it disrupts cash flow. This is particularly true for start-ups and struggling businesses.
Factoring occurs when an institution purchases an invoice for a price that is slightly less than the debt’s face value. This percentage can range between 70% and 90%. The factoring company then collects the entire amount due on the invoice and delivers it to the original business less a factoring fee.
Factoring is one method of resolving cash flow issues for businesses that offer credit terms as part of their sales. Many businesses that utilise factoring receive payment within 24 to 48 hours of the sale of their invoices. Additionally, this novel approach enables a business to offer competitive credit terms to their best customers without having to wait for credit payments. By offering attractive credit terms, a business can attract more customers. While most businesses compete on price, a business becomes significantly more appealing if it offers financing directly to its customers. Many consumers lack the funds necessary to pay for items in full, especially when a business advertises more expensive sales, but a customer may be able to agree on delayed payments. As a result, a business that offers this deal will sell more inventory than one that requires full payment up front.
It is critical to understand that factoring is not a loan or debt. Furthermore, unlike bank loans, no collateral is required. It is simply the sale of invoices for which individuals owe money to another business for a slightly lower percentage of the total due. The original business receives immediate cash, and the factoring company collects the debt’s face value in exchange for a fee.
Numerous businesses that extend credit use factoring to avoid the hassles associated with trying to collect money. Additionally, it is more expensive to maintain a billing department that is responsible for creating monthly invoices. By factoring, a business can eliminate the need for a billing department and save money on the administrative costs associated with debt collection.
Factoring cash flow enables businesses to acquire new equipment, pay off existing debts, increase marketing efforts, improve planning, process new credit approvals, improve customer relations, and save money on accounting procedures.