Many posts within this blog have discussed how business owners are not very familiar with receivables factoring. They might have heard of it, or not, someone told them it’s bad, or good, they might have a vague notion of how it works, or specific ideas that actually are incorrect.
So what is factoring? It is a simple commercial financing mechanism that allows a business owner to gain access to increased working capital by leveraging their finished work. What does that mean?
When you have a business and do work for a customer and offer them payment terms, thirty days for instance, the customer has received your services and now you are waiting to get paid. Your company has extended credit to your customer. In order to stay competitive with your competition you have to do what they do – which is offer credit on payment terms.
At this point your company becomes the lender. You are lending your customer money until they pay you back, and the invoice is your loan agreement. That piece of paper obligates the customer to pay you within the terms of the sales agreement.
So what if you don’t want, or can’t afford to wait thirty days to get paid for work you have completed and paid for in terms of labor and supplies.
A factoring company determines that your loan (invoice) is good and finances it. The factor checks the credit of the customer to make sure you loaned money to a creditworthy debtor and also verifies that the customer has accepted the finished work.
Your company gets paid today for work it completed and the factor waits until the customer pays the invoice. This happens as often as you would like and ultimately you are not borrowing any money and have no loan to pay off. You are leveraging finished work to gain access to working capital.