Factoring is defined as a method that enables a business owner to put up his accounts receivable for sale at a discount to a funding source in order to come up with the capital.
Basically, a business sells its invoices to a factoring company who pays the business a discounted amount off of the face value amount of these invoices, and then receives payment for the invoices from the company’s customers directly on the date that the invoices are due, i.e. in 30, 45, 60 or 90 days time.
It will surely surprise you once you discover the history of factoring. The contents of this article will not include the history of factoring but also a discussion on the advantages and disadvantages of factoring.
Almost since the dawn of civilization, there has been factoring. Factoring is a means of acquiring funding in exchange for anticipated payments. In the earliest times of civilization, 4,000 years ago, the Mesopotamians used factoring in their business dealings. Unfortunately, factoring at that time was hardly structured. Factoring is used by the ancient Romans using promissory notes sold on a discounted price at a secondary market.
Factoring gained true popularity, however, in trade between the American colonists and their European buyers. Before the American Revolution took place, merchants living in different colonies send all types of raw materials to other merchants like the British and the Europeans. However, sending the goods such long distances could get expensive. On the other hand, the travel time for payments from Britain and Europe take time and often causes delays in the harvest of plants and processing of new orders.
As a solution, British and European merchants pay part of the materials to the colonists. This way, the colonists had an advance with which to continue their operations. These eased cash flow and created a streamlined process for ensuring that trade continued unabated.
As society progressed after the American Revolution, and as the Industrial Revolution came, the focus of factoring changed. Credit became more important to factoring. The credit of the company itself was not as important as the credit of its clients. In fact, factors have helped companies determine which of its customers are creditworthy. In this manner, factors can keep the cash flow for these companies moving. They provide advances for capital based companies based on what their credit worthy customers owed them.
Before the 1930s, the most popular industries for factoring were the garment and textile industries. These materials depend heavily on raw materials. Factoring was used in order to make sure that these companies can continue buying raw materials in order to keep producing clothing and textiles. However, it soon became evident, after World War II, that factoring could work effectively for any business that invoiced others.
During the 1960s, 1970s and 1980s, interest rates were on the rise and banks were increasingly regulated. This made it difficult for companies to get traditional financing. This made factoring a whole lot more famous because credit checks are carried out in a different manner. Additionally, since the invoices were bought – minus a fee – it was possible to avoid the same sort of interest charges. Small business, start-ups and rapidly growing businesses benefitted especially from this increase in factoring. Factoring grew as a service as businesspeople found their options contracting.
At present, factoring is a viable alternative when traditional financing does not hold any promise. A good number of companies put up their accounts receivables for sale to factoring companies, which usually totals to billions of dollars. And nearly any business with reliable customers and an invoicing system can take advantage of factoring.
The Pros of Factoring:
The main advantage of invoice factoring is that it provides you with upfront cash rather quickly. Unlike traditional business loan, there is no need for you to wait for days, weeks or months in order to get financing. In most instances, a few days is needed in order to set up a factoring arrangement and the moment the set up is complete the money can be in your hands the next day.
Moreover, in factoring there is no need to re-apply on a regular basis just in case you need more money. Once there is an agreement, you can always sell your invoices over and over again without having to wait for any approval. And you get you money more quickly.
Factoring can be a great way to improve your company’s cash flow and ensure that you have the funds you need to keep operating your company.
As with all things, development of this industry has happened and today, different types of Factoring products exist, such as spot factoring, a newer type of invoice factoring, which you can use as part of your business growth strategy.
Spot factoring companies base their decision on the value and quality of your Invoices. There are no minimums, no maximums, no long-term commitments and no lengthy application processes when using a selective invoice factoring company.