subject: Using Paper To Finance Business [print this page] A recession or downturn in the economy often causes a business to look to some kind of alternative financing. Banks often change perimeters for loans when money available to small business becomes scarce.
If a business needs a transitional and time sensitive way of financing operational needs, it is possible to turn paper into cash through a process called accounts receivable financing or factoring. It is a debt-free way of having the cash needed for a new business in a growth mode. Factoring can be similar to having a line of credit except there is no debt created since it is the sale of some or all of the accounts receivable. When products and/or services have been delivered and an invoice has been created, it becomes an asset..
The requirements for a bank loan are different than for factoring. A loan requires a company to have good credit and most likely to have some collateral. When a bank makes a loan, it is standard procedure to file a UCC-1 in order to hold the company's assets as collateral. In order to factor accounts receivable, a bank is often asked to subordinate the lien to the factor. The factor must have a first collateral position on the accounts receivable in order to factor the invoices. Banks are often willing to do so in order to help their clients position their businesses to be able to pay back their loans.
Factors are generally not as interested in the creditworthiness of the company as much as in the clients of the company. The risk a factor takes in factoring is with the company's clients rather than the company. .
Many companies would not suffer from cash flow problems if their clients would pay within thirty days from the date of the invoice. However, many of the larger companies use their clout to extend a thirty-day invoice out to sixty days or even more. Smaller companies are willing to accept the extended time because it is still profitable and perhaps involves large orders. Furthermore, they don't want to cause contention in a profitable relationship where there are going to be future orders. a nightmare is created when financing accounts causes a business to not be able to meet operational need, fill orders, or pay rent, taxes and accounts payable. Factoring is the sale of an asset. Therefore, there are no restrictions on the use of the funds.
When a business has a credit line with a bank, it is usually for a maximum amount. In order to increase the amount, additional application is usually necessary. Factoring invoices can be considered to be a debt-free line of credit that will grow automatically as the business grows. Therefore, there is no need to apply for additional funding. Efforts can be devoted to efficiently running the business rather than having to waste valuable time applying and waiting for underwriting at the bank.
Factors will advance between 70-90% of an invoice depending on the industry. Once the client has paid the invoice in full, the factor will pay the other twenty percent minus a discount fee. This is similar to a company being paid for credit card invoices except factoring involves two installments in order to hold a reserve as security until the invoice has been paid. When considering the cost of factoring, a company must also consider the worth of time and anxiety involved in the application process.
Most factors will only require an aging accounts receivable report and accounts payable report in order to determine whether the accounts are factorable. Factors are able to make a decision quickly thus not leaving the business for weeks or even months waiting for a decision. Once a business has been approved for factoring, it takes about a week to ten days to get the initial funding. Outstanding invoices can be submitted initially. After the first advance, additional invoices can be paid almost immediately after being submitted to the factor.
Only business to business or business to government transactions can be factored. Construction and medical industries can be factored as well as manufacturing, distribution, temporary staffing and many, many other types of business. Factors typically do not factor consumer transactions. The main purpose of factoring is to increase a positive cash flow.
