When a business is taking orders and needing capital to fill additional orders and is not able to obtain conventional financing from a bank, there is a viable alternative for a business extending net 30 days invoicing to the government or other companies. Factoring is a process involving a factor that advances a percentage of invoices almost immediately. A reserve amount is held until the invoice has been paid. Then the factor pays the reserve minus a discount fee.
There are three main considerations a company should be able to supply answers to in order to determine whether invoices are able to be factored.
1. What industry or type of business is the business involved with?
2. Underwriters for the factor must determine whether the debtors have good credit?
3. Is there anyone who has filed a UCC-1 on their business?
The reason factors want to know what industry a company is involved with is because some specialize in construction. Other factors specialize in medical receivables. Manufacturing is an industry frequently financed by factoring.
Along with knowing whether the debtor has favorable credit, the factors want to know how long it takes for the debtor to pay invoices. Some factors prefer to factor those who always pay within 30 days. Other factors prefer to factor debtors who take 90 days. Why do they prefer debtors who take 90 days to pay? Often, large companies or the government take 90 days or longer to pay invoices but they are still an acceptable credit risk.
A factor has to have the first option as a lien holder. That is the reason for knowing about possible UCC-1 filings on the company. Often, when banks have filed a UCC-1, it is possible to get the bank to subordinate the lien on the accounts receivable.
An alternative way of positioning and leveraging a company's financing is to look at factoring as an alternative, time-sensitive and transitional way to finance. When a company is being prevented from growth due to a lack of credit and a lack of conventional funding, it should consider alternative financing such as factoring invoices or purchase orders. If cash flow is the only thing from preventing a company from growing, factoring should be considered if the company does business to business or business to government invoices.
A business that offers a service rather than a product should have a favorable track record in order to be eligible for invoice or purchase order financing. It is perhaps more of a possibility to factor when a business delivers products rather than services. However, factors will consider either or both. But the factor needs to be reasonably sure the company is going to have the integrity to fill service contracts.
Seasonal businesses often have cash flow issues due to fluctuations in number and size of orders. Often, government contracts are for larger amounts but difficult for smaller companies to finance. Again, this would be an ideal scenario for factoring.
It is not required that companies factor all invoices. Furthermore, it is not require that all of the invoices be submitted to the factor immediately after being issued to the client. Possibly, factoring is only needed on accounts that extend past 30 days.
The process of applying for factoring is not cumbersome and drawn out. In order to determine whether accounts receivable can be financed, underwriters must look at the aging accounts and accounts payable. Underwriters are able to determine the viability of the company and creditworthiness of its debtors. When underwriters determine it is possible to factor the company invoices, a proposal is generated discussing the terms and agreement. An initial funding takes about ten days. Thereafter, invoices are paid with 24-36 hours from the time they have been submitted.
One of the greatest features of factoring is that a factoring line grows automatically as the company grows. When a company starts filling more orders and submitting more invoices, the cash flows without having to apply for an increase in funding to meet the size or volume of invoices. The cash has to flow in order for the company to grow.