Factoring Financing Companies: How Do They Work?
Small-scale business owners, despite having stellar credit scores, may still have a hard time securing a business loan from traditional lenders. The good news is that businesses now get to have various financing options. Nowadays, many would turn to factoring financing companies.
Is It a Form of Financing?
Factoring is not a loan. This is what you often hear from people. But basically, it works just the same. It is a kind of financial service where a business sells its receivables to factoring firms at a discounted rate to have quick access to funds. It is important to differentiate between factoring and invoice discounting. The former sells the accounts receivables to a third party.
The factoring company will then pay the seller after doing the deductions. The rate ranges from 2 to 6%. The factor will pay only from 75 to 80% after the discount deduction.
What Are the Functions of Factor?
Before even deciding to go for this kind of financing option, it helps that you know the different functions of factor, which include the following:
- Financing: The factoring firm provides financing to the client by getting all of the account receivables. For many businesses, this is a good financing option.
- Maintaining a Sales Ledger: A factor maintains the client’s sales ledger. So once you sell the accounts receivable to the factoring company, they take care of all of the transactions.
- Money Collection: The factoring firm collects the funds the debtors of the clients. This way, the client can focus on the business.
- Credit Protection: In the event of non-recourse factoring, the factoring company shoulders the risk of the credit.
Types of Factor Financing
Depending on the financial requirements, there are different types of receivable factoring. These include the following:
- Recourse factoring: The factor is only a collecting agent. The client handles the credit risk and not by the factor company.
- Non-recourse factoring: In this case, the factor shoulders the risk of credit.
- Full factoring: This is considered to be the most popular type of factoring as it gives the client with various features like collection, protection from debt, etc.
- Suppliers guarantee factoring: In this kind of factoring, the factor takes guarantee of the firm.
What Are the Advantages of Factoring?
There are various advantages of accounts receivable factoring which include the following:
- When you sell your accounts receivable, it reduces your credit risk.
- In terms of your working capital, you can expect it to run smoothly as the factoring company can provide immediate funding.
- Factoring can actually help you improve your business liquidity as well as cash flow.
- You do not necessarily have to get new business capital.
How About the Disadvantages
As with any financing option, there are also downsides in deciding to go for factoring which includes the following:
- Since factor firms will collect the money on your behalf, it can lead to stress in the client relationship.
- If the factoring company exhibits bad behavior, it can affect the company.
- The factoring cost can be quite high.
What to Look for in a Factoring Company?
After taking the time to weigh your options and you have finally decided to go for factor financing, the next step is to start searching for a factoring company.
So, what are the things you have to consider?
- The reputation of the Company
Since you will be dealing with the factoring company and have financial transactions, it is logical that you find a reputable company. It is always best to choose a firm that is already established. For instance, find a factoring company that has more than 10 years of being in the business.
- Factoring Fees
As with any type of financing option, you should be able to understand the total fees that you will have to pay. You don’t want to experience being surprised having to pay for hidden fees. Make sure that you know under what conditions these fees apply.
- Know about the penalties.
Getting information pertaining to penalties is very crucial. You should know when these penalties are imposed. Knowing these details allow you to be careful in order to avoid incurring these penalties.
Factoring has its share of advantages and disadvantages. It will just depend on your business needs and other requirements. There are several reasons why a lot of business owners prefer to turn to factoring financing companies. If your business needs quick funding, this is one of the best ways to go. But just before you do, it is very important to select the right company in order for you to have a good experience. Keep in mind that selecting the wrong one can be really frustrating and may even lead to more problems.