The factoring industry is well established and comprised of both specialized factors for many industries and the giant factoring companies that are able to handle larger exposures with more sophisitcated requirements. Many companies factor during their entire existence; others only until they are able to manage credit on their own.
For smaller companies without alternative means of funding, factoring can be a lifeline that enables them to grow their business, not only purchasing receivables but also handling investors financing. There are various options for doing business with a factor, but it generally works this way.
Factoring Works This Way
- The factor purchases your receivables and advance you a percentage against them (say 80% by way of example). The 20% is held back in the event of customer deductions, markdowns or returns).
- Most factors will insist on factoring all of your sales, since otherwise they may be stuck with only the risky accounts, referred to as “adverse selection”.
- The factoring fee might be anywhere from 6/10 of 1% to 2 or 3 percent of the amount of your total sales. It all depends on the risk of bad debt they are assuming and the size of the invoices (it costs as much to handle a $100 invoice as a $1,000 invoice). Very risky accounts could be a higher percentage or might even be “client risk” if the factor deems them not too risky to guarantee.
- For their fee, a factor also handles the collection of your invoices, and your customer will know that you are factored (for some, this can be a perceived negative as it can imply financial weakness).
- The customer receipts go into an account set up at their bank, and you receive the net, minus fee, deductions, and client risk bad debts.
- Keep in mind that a factor will not finance or guarantee disputes or deductions, not will they manage or try to collect them for you. For deduction management, you must set up an internal department, the needed systems, or you can avoid that with expert deduction outsourcing.
If you are looking to increase your international business, there are many options available for financing those transactions, including factoring. We can help develop the best alternatives for you to consider, including a recommendation for protecting your receivable against default.
If you need any assistance with factoring questions or selection, please use our contact form or email our specialist.