Monday, December 11, 2006

Factoring 101

Where a business has already supplied goods and services to another business (not an individual consumer), it can sell the Invoice to a 3rd party for immediate cash at a discounted value, rather than waiting for its customer to pay up. Factoring is the sale of commercial paper. The 3rd party, having bought the Invoices from the business, now assumes the risk of obtaining payment from the customer.

The company that BUYS the invoices is the Factor (or funding source). The company that SELLS its invoices (also known as Accounts Receivables) is the Client. The company to whom the invoice was addressed, and which remains liable to pay the Client’s invoice, is the DEBTOR.

Having purchased the Receivables, the funding source will initially advance 75% - 90% of the invoice amount up front and will pay the remaining amount – minus a service fee – after the Client’s Debtor pays the full value of the invoice to the funding source. The service fee is expressed as a discount from the face value of the invoice. The discount varies according to the length of time the invoice has remained outstanding.

Factoring is NOT a loan. The Client sells its invoices to the Factor at a discounted amount in return for virtually immediate capital. There is no need for the Client to wait 30, 60, 90, 120 days or longer for its debtors to pay its invoices, or run the risk of declaring them as Bad Debts. In other words, the business that sold the invoices for cash, capitalized on the time value of money.

When a bank extends a line of credit, it means that the company is, or soon will be in debt. In private Factoring, there is no loan and there is no debt. The amount of money available pursuant to a sale of the invoices is based not on the creditworthiness of the company – but of its customers. As the company sells to creditworthy customers, more money is made available and the business can grow exponentially – debt free.

When deciding to factor, the funding source is more interested in the creditworthiness of the Debtor i.e. the payor of the Invoice, because the funding source, in buying the Invoice from the Client, will look to the Debtor for payment.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

No comments: