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What is Factoring and How it Benefits Businesses

Factoring is a financial tool, which allows you to immediately get money against your credit sales instead of waiting for it to mature. It is a process followed down from hundreds of years ago and now modified to suit various types of industries.

Basically, factoring means selling your credit invoices to a third party, called a factoring company and getting immediate payment against that invoice. The factoring company pays you the invoice amount in 2 installments. The first installment is about 60 to 90 percent of the invoice value and is posted electronically to your bank account with one or two days, and the second installment, minus the factoring company's fee is paid to you when your customer pays the invoice amount.

This fee is normally 1.5 to 5 percent of the invoice value and normally depends on factors such as your customers' credit rating with the factoring company, the number of credit days as mentioned on the invoice and the total value of business you give to the factoring company. In addition, factoring companies can also take care of your payment collection from your customers.

Factoring therefore is a boon for your business, if you have mostly credit sales to a wide range of customers. It not only improves your cash flow dramatically, enabling you to use that money for staff salaries, payments to your suppliers or even to buy in bulk quantities, but also frees up your collection staff which you can re-direct to some other department. It also frees you from the hassles of payment collection and worrying about customers not paying on time. The factoring company will give you regular updated statements of payments collected by them and the pending receivables statement.

Factoring is directly linked to your sales and hence is much better than trying to avail a bank loan, which might involve submission of many documents and collateral or guarantees and you will still have to pay interest on that loan. Through factoring, it is now possible to go in for a big order given by your customer, which previously would have locked your money. You can also make bulk purchases with the money received enabling you to get extra discount, which can be used to increase your sales and profit margins. So it is a win-win situation for you.

However, you should note that factoring is suitable only if you have a minimum of 15 percent of gross margin on your sales and that the credit period offered to your customers is not very high. Calculate your profit margin after deducting the factoring company's charges so that you can decide whether it is viable financially to employ their services. Also, since your customers will have to be informed about your arrangement with the factoring company, some of them might not be comfortable of making payments to third parties.

There are various types of factoring facilities available such as invoice factoring, purchase order factoring, etc. which have different percentage of charges. You can find different factoring companies advertising on the internet. You can even hire the services of a factoring broker to find you the right factoring company to match your needs. It normally takes a week or two to set it up.

So, go in for factoring and watch your bottom line and sales improve. It's easier than it sounds.

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