What Is Factoring?

Factoring, also referred to as accounts receivable financing, is a type of financing in which a company sells its accounts receivable (outstanding invoices) to a third party known as a factor. The factor will then advance up to 90% of the accounts receivable and also manage the accounts by collecting payments from the customers and following up when payments are past due. Upon receipt of payment, the factor is paid its fee and then remits the remaining unadvanced balance to the company. It’s very important to understand that factoring can be a vital cash flow tool for business growth.

 

In simple terms, factoring is the purchase of accounts receivable at a discount, which allows a business to convert its unpaid invoices into immediate cash. And accounts receivable financing is both flexible and virtually limitless when a company sells on terms to creditworthy customers—its access to capital is directly related to its sales, not to financial statements or personal credit scores.

The process of factoring helps businesses unlock the cash tied up in their invoices. Here’s how factoring works:

1. The business sells its product or service to customers.
2. The business sub-issues its invoices to the customer and copies Sky Business Credit (“Sky”).
3. Sky verifies or validates the invoices with the customer (when applicable).
4. Within 24 hours, Sky advances 80-90% of the invoice amount.
5. The customer sends payment to Sky when due.
6. As Sky collects, we return the remaining 10-20% to you, minus our small fee.
7. You sell Sky more invoices and continue the cash flow cycle.

There are four main types of factoring:

1. Non-recourse Factoring: This is when the factor assumes the risk of non-payment due to bankruptcy or proven financial inability to pay. Some businesses will lean towards non-recourse factoring thinking they don’t have to worry if their customer doesn’t pay for any reason. This is not the case. The business is responsible for all other reasons for non-payments. Non-recourse factoring is more expensive and has more stringent criteria to approve the business’s customers for qualifying for the amounts it may need to grow the business.
2. Spot Factoring: Also known as selective factoring, spot factoring occurs when a business sells a single invoice or small batch of invoices to the factor on a one-time or occasional basis. Spot Factoring is the most expensive type of factoring, and very few factors will provide this type of factoring.
3. Invoice Discounting: The business sells all of its invoices to a factor and draws money against the invoices. With invoice discounting, administrative fees are charged on all invoices even if the factor does not include them all in their eligibility criteria for calculating available funds to draw against.
4. Recourse Factoring: this is the most traditional and commonly used form of factoring; the factor advances monies against the invoices of creditworthy customers and fees are only charged at the time an advance is made. In most instances, Sky allows its clients to choose which customers to factor and they retain the management and receive payments themselves on the customers they are not factoring. Typically, if an invoice is not paid by the time it is 90 days old, the factor will look to be paid back its advance from other invoice advances or, in most cases, the reserve from other paid invoices. (Note: “reserve” is the remaining amount that is sent to the business after invoices are paid.)

 

Sky Business Credit offers recourse factoring.

Factoring offers several benefits to businesses:

 

Improved Cash Flow

Factoring provides an immediate infusion of cash, allowing businesses to cover their operational expenses, invest in growth opportunities, and meet their financial obligations without waiting for customer payments.

 

Improved Risk Management

As a condition of factoring, factors will conduct a credit review of the business’ customers to determine their credit risk. The factor will identify risky credit decisions, which helps the business reduce or even eliminate sales to customers who don’t pay.

 

Efficient Collections Process

Factoring eliminates the need for businesses to allocate resources and time to collect payments. The factor handles the collections process, enabling the business to invest that time and effort into other, more valuable activities such as new sales/business development.

 

Flexibility and Scalability

Factoring can be tailored to suit the specific needs of businesses. Whether the factoring agreement encompasses one customer or all customers, factoring provides flexibility and scalability as a business’s financial requirements change over time.

There are many ways factoring can help a business including, but not limited to:

• Pay payroll on time
• Pay supplier and vendor payments on time
• Take advantage of quick pay discounts
• Pay taxes on time
• Pay bills on time
• Extend payment terms to customers that weren’t previously possible
• Fund business growth
• Credit and collections assistance (saves administrative costs)
• Buy new equipment
• Increase inventory
• New marketing initiatives

 

Factoring offers quick, flexible access to funding that improves cash flow and funds growth, without additional debt.

Factoring is for growing companies that are unable to increase sales or take on new business because they don’t have adequate cash flow. They may be waiting on customers to pay invoices or need to front costs for supplies or overhead, among other challenges. Financing your receivables with factoring can keep you afloat and help the business grow and thrive.

 

Industries that may benefit from factoring include, but are not limited to:

• Healthcare staffing agencies
• Temporary staffing companies
• Wholesalers/distributors
• Manufacturing companies
• Construction companies
• Oil and gas industry companies
• Trucking companies
• Service providers
• Janitorial and cleaning companies
• Security companies
• Other services

The primary role of a factor is to purchase a business’s accounts receivable (invoices) and, in exchange, provide immediate cash advances. But a factor provides other valuable services, too, including:

• Receivables Management: The factor monitors the debt owed to the business from its customers, and helps ensure customers pay their invoices, on time and in full. In turn, this helps the business manage its cash flow more effectively.
• Collections Assistance: Once the factor purchases an invoice, it manages the collection process, including follow-up on past due invoices, to ensure timely payments.
• Reporting: accounts receivable aging, purchase and sale reports, payment reports. Businesses give our end-of-year reports to their accountants. Factors are like a back office that accountants rely on for proper record keeping in many instances.

 

The business gets real-time access to everything we know: reports of outstanding invoices, payments, collection notes, etc. Our clients rely on us to keep track of what they have outstanding. The business benefits from daily, monthly, and/or year-end reporting when they work with a factor.

While eligibility and qualifications for factoring may vary, here are the key factors Sky considers when evaluating our clients:

• Creditworthiness of Customers: Since we rely on your customers’ ability to pay their outstanding invoices, we will assess your customer’s creditworthiness.
• Type of Business: Factoring has benefits across various industries; however, the business must have accounts receivable.
• Invoices with Payment Terms: Complete and accurate invoices with backup documentation to ensure quicker payment.
• True Sales: no consignment, no bill and hold, no contra (i.e., a buying/selling relationship going both ways with a business and its customer)

The approval process to factor may vary; Sky’s three-step approval to factor is quick and easy:

1. Complete and submit a free, no-risk application.
2. Sky will issue a proposal of terms, including fees and other terms of your account.
3. Once the proposal is signed, Sky will request a few additional documents so we can do our due diligence on your customers and finalize your funding.

 

The time from application to funding is approximately two to four business days. Sky will move as quickly as the business responds.

While factoring offers numerous advantages, there are a few things to consider:

 

Customer Perception

Factors will work directly with your customers to collect payment. However, customers’ accounts are used to paying invoices through outside third parties—and typically accounting is the only department that notices the change in remittance. In addition, factors are professionals at managing and collecting receivables.

 

Cost

Factoring fees can be higher, depending on how you use it and what you compare it to. In most cases, it’s less than credit card processing fees. It’s also less expensive than passing on a sales opportunity because you lack the cash to produce and deliver.

 

Quality of Receivables

Factors evaluate the creditworthiness of a business’s customers before purchasing their invoices. If a business’s customers have poor credit or bad payment histories, factors may either decline to purchase those invoices or offer a lower funding limit for those customers. The business can also then use this information to mitigate bad risks.

Factoring is a type of alternative financing that is not as well-known as traditional bank financing. Here are some common questions about factoring:

 

How does factoring differ from a bank loan?

At the highest level, factoring is a sale of accounts receivable in exchange for immediate cash. A bank loan is a debt that involves borrowing a specific amount of money for a fixed term and with set repayment terms.

 

What are the costs and fees associated with factoring?

Sky Business Credit charges a straightforward discount fee, starting between 1.5-3% of the amount of the invoice. Fees depend upon a few factors, such as the size of the account, whether the customer has monthly minimums for factoring or none, the industry the business is in, and the length and flexibility of the contract. With Sky, there are no additional fees, monthly or otherwise.

 

Are factoring fees deductible?

Yes. Factoring fees can be deducted as a business expense.

 

How long does it take to get funded through factoring?

It’s almost immediate. From application review to finalizing legal documents, the process can take as little as 24-48 hours.

 

Can I still factor if my business has poor credit?

Yes, you can still factor if you or your business have poor credit. Sky doesn’t care about your personal credit score. We care about how creditworthy your customers are.

 

How does the factor evaluate my customers’ credit?

Commercial credit reporting agencies are used such as Dunn & Bradstreet and Cortera. If your customer has a track record of on-time payments, we can almost certainly work with you.

 

Can I factor invoices that are already past due?

It depends. We will discuss your immediate cash flow needs and maximize your initial funding with the outstanding invoices. If the invoice is past due, we’ll verify the invoice and when it’s going to be paid to determine your funding options.

 

Will factoring impact my relationship with my customers?

This is a top concern of many businesses. The truth is, customers are used to paying invoices through outside third parties—they don’t care who is listed on the invoice! In addition, we’re professionals at managing and collecting receivables and we try to be as least intrusive as possible.

 

If you have other questions about factoring, we want to answer them! Reach out to talk.

If your business needs cash flow to grow, it’s important to carefully evaluate your specific financial needs, consider the associated costs and risks, and assess whether factoring aligns with your long-term objectives. We want you to make an informed decision that’s best for your business and can help you by providing honest, direct insights into your financing options.