What is a Factoring Company?

Chances are if you’re a business owner and you’ve found this article, you’re considering various financing options available to you. Alternative financing options are becoming more prevalent with the expansion on online lenders, so you may be asking “What is a factoring company?”

A factoring company is a financing partner who helps businesses in need of faster cash flow. These businesses typically face timing challenges of slow-paying customers or need funds to ramp up growth. Factoring companies come in many varieties – independent financiers, financial institutions and multinational corporations to name a few.

Each factoring company has its own way of doing things, but they all share the common function of purchasing a business’s accounts receivable (AR). A business’s AR represents goods or services already produced and delivered to the buyer. The business has invoiced their customer which is why this type of financing is known as invoice factoring.

How Factoring Works

A factoring company works with a business, as well as with the business’s customers (account debtors), to accelerate the movement of cash flow through the business. A detailed look at how factoring works shows the involvement of each party.

 

Industries that Use Factoring

A growing number of businesses are turning to invoice factoring as a reliable financing option. The Could Factoring be a Fit? table outlines the typical needs and profile of a business looking at financing options.

Businesses that operate in a business-to-business setting where invoices are generated are ideal for factoring. The most common industries utilizing factoring include:

• Staffing
• Distribution
• Facility Services
• Manufacturing
• Consulting
• Food & Beverage
• Wholesale
• Professional Services
• Textile & Apparel
• Oil & Gas
• Janitorial Services

Factoring Company Helps Toy Manufacturer

An example illustrates how a factoring company helps a manufacturer take advantage of a growth opportunity:

Imagine a small toy manufacturer ABC Toys selling child walkers that light-up and play music. The company receives an order from Wal-Mart for 10,000 units for a face value of $1,000,000 so the wholesale price is $100. Payment terms are three months after the goods are received.

The manufacturing cost per unit of $50 includes the electronics, plastic materials, assembly and shipping. After spending the $500,000 to produce the product, ABC Toys is running short on cash and eager to fulfill more orders at Wal-Mart or other stores while they wait the three months for payment. ABC Toys will lose the opportunity to produce more unless they come up with the financing. This is where factoring comes in.

A factoring company can come in and front the $1,000,000 owed by Wal-Mart minus a small factoring fee. Everybody wins as ABC Toys gets the money to make another production run and make even more profit. Meanwhile, the factoring company awaits the $1,000,000 payment from Wal-Mart at the end of 90 days.

Benefits of Working with a Factoring Company

There are many benefits to working with a factoring company as opposed to other types of financing. These include:

• Work with start-ups and small businesses
• Cash flow improves immediately, no longer tied up in accounts receivable
• As a business grows, so does the amount of funding available
• Credit profile of business owner less important, value creditworthiness of customers
• Verification services and credit analysis offer support and peace of mind to business owner

 

What does a Factoring Company Look for?

Traditional commercial financing options such as bank loans and lines of credit require a strong credit profile, solid operating performance and valuable collateral. As a traditional bank lender, we know first-hand that many businesses don’t meet these lending criteria. A factoring company evaluates businesses with different criteria than used for traditional lending options. This post on invoice factoring vs bank loans highlights the differences.

Factoring Companies Look at:

• Creditworthiness of the Business’s Customers

A factoring company looks at the business’s customers to assess the credit risk. Large public companies like Wal-Mart, Whole Foods, Target and Home Depot are A+ credit risks that most any factoring company will accept. Smaller firms or ones that are in a perilous financial state will require a more through underwriting process by the factoring firm which may take days or weeks.

• Average Age of Accounts Receivable

A factoring company requests an AR aging report so that they can determine the average age of accounts receivable. This is an important attribute because it indicates to the factoring company how long they will await repayment. Faster paying customers are preferred, but factoring companies will work with customers who take as long as 90 or 120 days to pay depending on their individual parameters. Slower paying customers typically equate to a higher factor fee, so it’s important that the business owner understand how long it takes a customer to pay and build that amount into their margin.

• Amount of Financing the Business Needs

Factoring companies work with business of all sizes – startups to large corporations. Different factoring companies focus on different levels of financial need. Some focus on startup and small businesses, while others are better suited for multi-national companies with export and import needs. The factoring company will want to know your level of financial need – approximately how much you’ll need on a monthly basis. This variable will help determine if you fit the factoring company’s client profile or if they should direct you to find another financing partner. The amount your business needs will correlate to the factoring rate. Based of the economies of scale theory, a larger volume will be associated with a lower factoring rate.

• Concentration of Customers

Since a factoring company is evaluating the potential risk associated with your customer base, customer concentration will be considered. It is preferable to see a healthy mix of different customers. For example, if a single customer accounts for 90% of your revenue, this would be a red flag for a factoring company. They would be reluctant to accept the level of risk associated with having so many eggs in one basket.

Steps to Working with a Factoring Company

There are several steps to working with a factoring company.

  1. First and most important, find a reputable factoring services provider. This can happen through a referral from a business banker or accountant. Also, business resource sites such as Business News Daily and Fit Small Business list and review factoring service providers.
  2. Submit an application. Information about the company’s history, the ownership structure, the credit history of the company and the financial state of the firm will be requested by a factoring company as part of the underwriting process.
  3. Review proposal to ensure you fully understand rates, fees, term length and any vague language. Like any financing agreement, factoring contracts are known for their complexity. Make sure you are working with a partner who can walk you through each step of the way with full transparency.
  4. Integrate your factoring company into your process. Your chosen factoring company will become an extension of your business. They will process your receivables, verify jobs and follow up on collections. When executed successfully with a reliable factoring partner, you can get back to running your business with a heightened level of flexibility that factoring brings.

Want to Know More?

If you have unanswered questions or want to know more about how a factoring company might help your business, please submit the form below and we’ll be in touch soon.

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Invoice Factoring for Consulting Firms

If you own or manage a consulting firm, you know that cash flow can be a problem. You incur unusually heavy upfront costs—to hire the best professionals and ensure they receive the ongoing training they need to remain up-to-date. However, the very clients you work so hard to help are sometimes hesitant to pay you on time. In addition, the work you do is irregular—you might have 3 projects one month, but none the next. Small business provider Insureon aptly describes the nature of the problem:

“As a management consultant, you’ve helped all kinds of clients improve their profitability, increase their revenue, and manage their finances — so it’s somewhat ironic that small consulting firms often struggle with their own cash flow problems. With the feast or famine nature of your work, consulting firms have highly irregular income and will need to take precautions to weather lean months and ensure they’re saving enough of their revenue during busy times.”

How Do You Improve Cash Flow?

There are several potential solutions to the cash flow problem many consulting firms face. For example, you could require clients to pay an upfront deposit for each project, or offer monthly payment plans. One of the most effective solutions, however, is invoice factoring.

What Is Invoice Factoring?

Invoice factoring works as an arrangement where you sell your clients’ invoices to a third-party, called a “factor,” who becomes responsible for collecting payments. The factor typically pays you the majority of the invoice immediately. Once clients have paid invoices in full, the factor deducts its fee and sends you the remainder of collected funds to close the account.

What Are the Benefits of Invoice Factoring?

Maintaining a healthy business relationship with key clients is critical to your consulting business—one of the chief benefits of invoice factoring is that you can maintain a healthy relationship with clients, since that relationship is no longer muddied by requests for payment, requests that can sometimes lead clients to search for another consulting firm.

In addition, working with a factor can remove the need for your firm to take on additional debt to maintain a healthy cash flow. This is especially important for firms whose credit limit is already stretched. With invoice factoring, you avoid the need to submit to yet another credit check or open an additional line or credit.

How Do I Find the Best Factoring Company for My Business?

Different factoring companies have various levels of expertise, and serve different kinds of businesses. They also have varying fee structures, contract terms and programs. The goal is to find the factoring company which is best for your consulting firm. Doing so requires considering several factors, including the following three:

1. Which Type of Factoring Company Is Best for Me?

There are 3 basic types of factoring arrangements:

  • Recourse factoring – This arrangement is the most common and the least expensive of the options. You, the consulting firm, assume the risk if clients fail to pay the factoring company, so make sure you choose to work with a factoring company who helps with credit services. By finding a partner who provides strong credit analysis of your clients, you will be in a better position to ensure full repayment.
  • Non-recourse factoring –  In this scenario, the factoring company assumes the risk for non-payment. In other words, if your client fails to pay, you are not responsible to repay the factoring company. Because risk is higher for the factoring company, they tend to charge higher fees.
  • Spot factoring – This entails a single invoice payment on a one-time basis.

2. How Much Will it Cost?

It’s important to compare multiple factoring companies before you make your final selection. Read the fine print in your contract, because their fee structures vary greatly. Pay special attention to advance, factoring fees, reserve requirements and whatever additional fees the company charges (such as processing fees). If you find the several proposals you receive confusing, check with a trusted bank partner or financing company to help you make your choice.

3. How Will They Treat My Clients?

The last thing you need is for a third-party to employ the aggressive tactics of some collection agencies—that can defeat the purpose of hiring the factoring company in the first place, since you could lose clients and needed revenues. Make sure the factoring company you choose will provide the same level of customer service you, yourself, provide your valued clients. Before making your final selection, check for customer reviews, and always ask the factoring company for references.

Conclusion

Successfully managing your consulting firm can be complicated, and you can’t expect yourself to be an expert on every subject. From time to time, you’ll need to work with a trusted and experienced partner, whether you need help with invoice factoring, accounts receivable financing, or asset based lending. To learn more about the ways The Southern Bank Company can help you grow your consulting firm and maximize profits, contact us today.

 

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Choosing the Best Factoring Company

With so many options, choosing the best factoring company for your business may seem overwhelming. No two factoring companies do things exactly the same – they specialize in different industries, offer different terms and use different language. These differences make comparing factoring companies difficult.

Five questions to ask a factoring company:

1. How long have you been in business?

The best factoring companies have experience in the industry. Anyone with access to capital can set up a factoring operation, so by selecting a partner with several years of experience you automatically eliminate those factoring companies without a proven and stable operating history. The best factoring companies have invested time in improving procedures and protocols to give your business and your customers the best possible experience.

The International Factoring Association (IFA)’s latest Factoring Industry Survey states that 25% of factoring companies surveyed have been in business five years or less. While the influx of new factoring companies ultimately helps businesses through increased competition, make sure that your factoring company has been in business at least two years.

2. What are your terms, fees and funding limits?

The nuances of the financial details present the most variability when choosing the best factoring company for your business. Review proposals and contracts with your accountant to minimize unexpected financial impact.

The terms of the agreement include such aspects as contract length and whether every (or select) invoices will be factored. The industry standard is one to two years for an agreement term. Agreements typically auto-renew if 60 or 90-day notice isn’t given. Some factoring companies require factoring all invoices, while others allow for select invoices to be factored.

Fees can quickly add up and affect your bottom line. The best factoring companies present fees in an upfront manner and don’t try to sneak them in. Some fees to look out for include:

  • application fee
  • monitoring fee
  • credit reporting fee
  • fee for adding a new factoring customer
  • ACH fee
  • wire fee – for all wire transfers the Federal Reserve charges a convenience fee, but some factoring companies increase that fee
  • monthly volume fee – while this is a common fee to ensure the factoring partnership is being utilized, watch out for excessive rates
  • early termination fee – another common fee, but watch for high rates and long notification period

The funding limit describes the capacity of the line your business will be able to receive. Whether $100,000 or $100,000,000, you want a factoring partner who openly discusses these limitations. As your business grows, you’ll want to have a plan for the next phase. You don’t want to wait until you’re up against the limit to make the plan. Find a partner who can grow with you.

3. How frequently and quickly will our invoices be funded and payments applied?

The best factoring companies allow a business to submit and factor invoices daily. The business presents the invoices, while the factoring team processes and funds within 12-24 hours. Since some factoring companies take longer to process and fund your receivables, make sure your factoring company’s speed matches your cash flow needs.

When your customers’ payments arrive in the lockbox, you want the payment amount applied to your account quickly. The “float” impacts your outstanding balance and the amount of your factoring fees, so can significantly affect your bottom line. Look for payments to be applied daily.

4. How does the factoring company interact with my customers?

The best factoring companies receive your consent to interact with your customers. In these scenarios you’re aware of communication with your most valuable relationships – your customers. Many factoring companies will reach out to your customers whether or not you’re aware of it. This type of unexpected communication can build tension in a customer relationship. Find a factoring partner who is willing to take additional steps to make you feel comfortable with the level of interaction and keeps you informed of the contact.

5. Where are the funds coming from?

The funds that the factoring company advances you are coming from somewhere. Find out where. Knowing the origins will help you better understand how competitive your cost of funds is. A direct lender, such as a bank factoring company, receives funds from its rich deposit base, so the cost of funds is low. A bank-backed factoring company passes along these savings to factoring customers in the form of low rates.

Traditional factoring companies and independent financing companies must borrow the funds from someone else, so they serve as middlemen. As a result, the rates you pay these companies typically run higher to cover the additional cost of the borrowed money they advance your business.

Here to help

Looking for recommendations?  Not sure if you’re getting the full story from your current factoring partner? Don’t hesitate to contact us today and we’d be happy to provide our thoughts and help guide you in your decision process.


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Bank Factoring Company Offers Flexibility

What is Bank Factoring?

Factoring is a transaction between a business and a third-party (the factor) which provides quick cash flow in exchange for accounts receivable and/or other assets. A business can use its invoices (accounts receivable) as leverage or sell off accounts receivable to the factor to obtain cash. Depending on the arrangement, the cash is either discounted or reduced by fees charged by the factor. A bank factoring company uses the same steps as a traditional factoring company, but requires the factor to be a regulated bank. There are many nuances and differences across traditional factoring companies, bank factoring companies and independent financing companies. Each factoring company has its own way of defining the types of factoring available.

With altLINE we break out our accounts receivable-based products into three structures:

  1. The first is asset based lending which is a loan secured by business assets. The collateral is either the inventory, accounts receivable or balance sheet assets. Since asset lending is similar to a revolving line of credit, the business can borrow from assets on a continual basis to cover expenses as needed.
  2. In accounts receivable financing, a business sells the value of its invoices to a third-party factor (ie. independent factoring company or a factoring bank) at a discount. The third-party processes the invoices and the business receives funds based on the expected money due from their client (the debtor). This structure operates similarly to a line of line of credit.
  3. Invoice factoring is the third method, in which a business sells invoices to the third-party (the factor). The factor gives the business a percentage of the total value of invoices and collects invoice payments from the business’ client. After the client pays the invoice, the factor pays the business the remainder of the money collected and keeps back a transaction fee.

As a bank factoring company, altLINE offers various accounts receivable financing structures to fit the varying needs of a business.

Benefits of Factoring

Factoring is not a loan thereby no liability is reflected on the balance sheet. It establishes steady cash flow and eliminates the 30, 60, 90-day waiting period for the accounts receivable of a business. The factoring company manages invoices and implements credit reviews of the clients for the business. The factor advances funds against invoices and collects money owed by the business clients. Time management is optimized and the business can direct its energy towards sales, market expansion, and other endeavors.

Why factor?

1. Funds are advanced to the business before clients pay the invoice for goods received.
2. Factors provide credit control – the collection of funds is managed by the factoring entity.
3. Factoring provides capital while the business has open invoices.
4. Factoring is not a loan since the invoices/accounts are purchased by the factoring entity. They do not show on the books as a liability so this reduces balance sheet debt.
5. Businesses which experience seasonal fluctuations in their business have periods of insolvency; factoring is a means of acquiring cash flow based on money owed by clients.
6. Quick access to funds with invoice factoring – funds available within 48 hours after an invoice is generated.
7. Relief from debt collection.
8. No debt to repay.

Factoring Companies –Many Choices

Since there are limited barriers to entry anyone can start a factoring company. As you would expect, some factoring companies are better than others. Take the time to research and get comfortable with your factoring partner. The two types of factoring companies compared here are independent factoring companies and bank factoring companies (also known as a factoring bank).

Independent factoring company

Independent factoring companies work with businesses who need to accelerate cash flow and may have been turned down by a bank. A business with creditworthy customers may be eligible to factor even if it can’t qualify for a loan. In factoring, the factoring company is concerned with the creditworthiness of the client versus the business.

Bank factoring company

A bank factoring company provides the same flexibility and benefits as an independent factoring company, but also offers additional advantages.

A bank factoring company works with many businesses who are considered outside of the traditional credit box. Many of these businesses have been told “no” by a bank for a commercial loan, but they are still very strong candidates for working with a bank owned factoring company. Businesses that work with a bank owned factoring company may also have an easier time transitioning to a commercial loan at a later date.

Banks are more secure and provide a sense of financial stability for the business. A business’s clients are very valuable relationships and a bank owned factoring company offers a level of comfort not found in independent financing companies. Clients feel better about interacting with a bank than an unfamiliar or unknown business entity.

In addition, since the bank has its own funds a bank owned factoring company can offer the business very competitive rates. Unlike many independent factoring companies who work with multiple funding sources, a bank owned factoring company acts as a direct source of funds and eliminates the middleman.

Factoring is a common solution to cash flow and is best used during growth periods or when the account receivables are large. The business benefits since the time between delivery of goods and funds realized is short. The business is relieved of the burden of chasing debt and can focus on other pertinent issues.

Contact us today to see how factoring with a bank can help your business grow.

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Comparing Factoring Companies

If you’ve already determined factoring, or Accounts Receivable financing, is the right fit for your business or you’re in the early stages of researching and comparing factoring companies, it’s important to keep a few things in mind.

Get it Right the First Time

First, there is no shortage of options. In fact, there are hundreds of financial companies that are willing to work with you to finance your business. While choice is good, identifying the right factoring company is crucial. Before signing a contract, spend the time up front talking to industry peers, business advisers, and researching online to ensure you’re speaking with reputable companies.

Factoring contracts use familiar financial terms, but the impact of these terms can feel foreign if you haven’t factored before. Many factoring companies utilize fees (transaction, lock-box, monthly minimums, etc.) in conjunction with interest rates to increase their revenue. Don’t be fooled by low teaser rates with seemingly small fees. You may later realize that you’re in fact paying significantly more than your competitor.

Also, be weary of long-term contracts that include large termination fees, right of first refusal, and other terms that may limit your flexibility and ability to make a change in the future.

Comparing Factoring Companies – More than Cost

Like all businesses, factoring companies have labor costs. Your factoring company’s labor directly interacts with your customers on a daily basis in the collection of receivables. The most important, and perhaps most overlooked, trait you should look for in your factor is the factoring company’s ability to manage and protect the relationship between you and your customers. When comparing factoring companies, make sure you’re not basing your choice solely on cost and select a company that invests in their people because your factors staff will in many ways be perceived as representative of your own company.

Questions? Contact The Southern Bank

Looking for recommendations? Trying to analyze a complex agreement? Not sure if you’re getting the full story from your current partner? Don’t hesitate to contact us today.  We’re happy to provide our thoughts and help guide you in your decision process.


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Factoring for Manufacturing Companies & Top Industry Challenges in 2017

Earning a top position among manufacturing companies is becoming increasingly difficult due to the rapidly changing landscape of the manufacturing industry. Amid the many challenges facing manufacturers today are employee skills gaps, cash flow hindrances, and keeping up with innovation. Here at altLINE, our team specializes in factoring for manufacturing companies. Below we look at the top three challenges facing companies as they strive to prosper in the increasingly competitive manufacturing industry.

Challenge 1: Skills Gap

Since the end of the recession in 2009, job postings in the manufacturing industry have increased 280% while the percentage of people hired has risen at a small fraction of that rate. The Wall Street Journal and other sources point to a skills gap to explain why thousands of manufacturing jobs were unfilled despite the number of open positions being the highest since 2001. Specifically, today’s manufacturing jobs require a host of technical skills which applicants lack.

 

While manufacturers do not have direct control over the statistics above, they can meet the skills gap challenge head on with a strong commitment to robust on-the-job training. Employers must be more willing to hire motivated job candidates who display basic proficiency for a manufacturing position and a strong aptitude for learning. Then, they must follow through by keeping employees engaged in the training process.

Challenge 2: Cash Flow Problems

Cash flow problems can present a serious threat to manufacturers, especially when they arise during peak seasons. Many factors cause cash flow problems, but there are several reasons why manufactures find themselves short on cash. The majority of these problems relate to slow paying customers or the receipt of an unexpected large order that becomes difficult to fill.

The good news about cash flow problems lies in the wide array of options to resolving them. The key to conquering cash flow problems is to adopt one or more of the following strategies:

  • Screen new clients more carefully before extending payment terms
  • Offer discounts or other incentives to customers who pay in advance
  • Strengthen your collections efforts to obtain payment from delinquent clients
  • Utilize invoice factoring to revitalize your cash flow

Invoice Factoring for Manufacturing Companies

Unlike the first three strategies, invoice factoring can make a big impact in a short amount of time. Invoice factoring is particularly effective because it can generate cash quickly with little impact on the customer relationship. Since a factoring company advances funds against outstanding invoices, customers do not feel pressured to pay invoices more quickly than originally stipulated. A manufacturer should consider a customer’s credit quality, payment history, and longevity prior to using invoice factoring to address cash flow problems. Factoring companies will use those criteria to assess a manufacturer’s fit for invoice factoring. Take a look at this table to see which type of financing fits your business.

Challenge #3: Increased Automation and Innovation

The benefits of automation are undeniable. Increased efficiency, a reduction in errors, and faster production comprise three of the most impressive benefits offered by automation. However, automation requires investment and a culture of innovation. Manufacturers must be ready to address these potential growing pains associated with the introduction of automation:

  • Resistance to change exhibited by long-time employees
  • The need for increased emphasis on training of employees to oversee complex automation tools
  • The possibility that they will ultimately need to reduce the number of full-time employees due to automation

Successfully introducing automation to an organization requires an employer be prepared for potential employee resistance and to develop a more robust training platform. Additionally, manufacturers should highlight the ways that automation will benefit each individual employee. If employees see how they can benefit from automation, they will be more accepting of innovative changes.

Here at The Southern Bank, our team understands the industry specific needs of our clients. Our manufacturing clients rely on us to know their business’s unique challenges.

Contact us today to discuss invoice factoring for your manufacturing company.

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Invoice Factoring vs Bank Loans

Factoring & Bank Loan Comparison

The comparison of factoring vs bank loans comes up often among businesses looking to access working capital. As a factoring bank, The Southern Bank offers a unique perspective on answering this question. We provide businesses in all industries and sizes a broad range of commercial lending options. These include invoice factoring and traditional bank loans. We also help transition borrowers from factoring to traditional bank loans. While factoring and bank loans both inject much needed capital into a business, the two options are more different than alike. Here, we’ll assess factoring vs bank loans to give business owner’s an idea of how these two financing options compare.

Need for Funding

Every business needs funding at some point – to get started, meet payroll, invest in marketing or cover other expenses. Self-funding or borrowing from friends and family often serves as an initial starting place. A business’s primary banking relationship often becomes the next step in the quest for funding. Even though the bank may know the business and owners personally, meeting the lending criteria for traditional bank loans has become very difficult. In cases like this, exploring the differences between factoring and bank loans, as well as other alternate funding sources, makes sense for businesses trying to fully evaluate their financing options.

Bank Loans Difficult to Secure

Although the lending market has strengthened in recent years, the effects of the last financial crisis are still being felt by business owners. In the wake of tightening underwriting criteria, many businesses have faced turndowns by a bank. Bank underwriting criteria are notoriously stringent. As a baseline, applicants need a business plan and solid credit profile to be considered for a line of credit or loan. From there, the “5 Cs” of credit analysis also weigh into the decision.

5 Cs a Bank Uses to Assess a Borrower

• Capacity- Ability to repay, cash flow of business, timing for repayment
• Capital – Money you personally have in the business
• Collateral – For a secured loan, the assets that you will pledge
• Conditions – What the money will be used for
• Character – General impression of the individual

 

With all this information the bank will then make a risk determination and assess confidence in the business’s ability to repay the commitment. The bottom line is that traditional loans are hard to secure. Even if a business does get approved for a loan, it’s often not for the full required amount the business needs.

If the Bank Tells you “No”

While a business should explore traditional options, management should not get discouraged if the bank comes back with a “no” for a loan or line of credit request. It is not uncommon for a business to be turned down. Even if the bank can’t extend a traditional bank loan, the bank can provide a referral for an alternative type of funding if one is not available in-house. Here at The Southern Bank, we maintain the unique position of serving businesses as a factoring bank. When a primary banking partner can’t help, we step in as a FDIC-insured factoring partner to help the business in need.

 

Independent factoring companies and finance companies also operate in this space. Many of these companies function as a middleman and don’t have the same direct access and low cost of funds as a factoring bank partner. There is also a lot of buzz around online lenders and newer alternative funding sources. Many of these companies lead with very low teaser rates or sneak in complicated deal structures. As you determine if factoring or another alternative funding option can work for your business, be sure to fully vet a stable and trustworthy financing partner.

Is Factoring a Fit?

When traditional bank loans aren’t a fit, invoice factoring provides a fast and flexible way to fund a business. Factoring helps a business unlock the value tied up in its accounts receivable. Hence, the alternate names accounts receivable financing or accounts receivable factoring also describe factoring. In invoice factoring, a business sells its invoices to a factoring company in exchange for an advance on those funds. Factoring allows business-to-business firms the ability to get out from under a cash crunch by accelerating the business’s cash flow. See this How Factoring Works diagram for more detail.

Although factoring has been around as long as people have been trading goods, many business owners don’t know about factoring. Since most business owners have an understanding of how traditional bank loans work, we’ll take a look at factoring vs bank loans from this perspective.

The Main Differences

Factoring vs. Bank Loans Table

 

factoring vs bank loans

As the chart summarizes, speed and flexibility are the drivers behind the difference between factoring vs. bank loans. We’re here to answer any further questions you may have.


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What is Factoring? 10 FAQs

Q: What is factoring?

A: Factoring, also known as invoice factoring, allows a business to receive money owed to it in advance of collection. Rather than waiting 30, 60 or 90 days to receive payment, factoring provides a business-to-business company with much faster access to its money.

Q: How does factoring work?

A: A business engages with a factoring company  or independent financing company to create a factoring partnership. In this arrangement, the business sells its accounts receivable or outstanding invoices. The steps include:

1. The business sends a copy of the invoice to the factoring company.
2. The factoring company quickly advances 80-90% of the invoice amount into to the business’s bank account.
3. The business’s customer sends payment to a lockbox in the business’s name according to payment terms.
4. The factor releases the remaining 10-20% minus a small administrative fee into the business’s bank account.
5. The factoring arrangement gives the business faster access to cash, allowing the business to use the money immediately as it sees fit.

See this post for more detail on the factoring process.

Q: Is factoring expensive?

A: Factoring offers flexibility when traditional financing options aren’t a fit. Factoring rates tend to be higher than conventional business loan rates, but great variability exists among how different factoring companies structure deals. Finding a reputable partner with a transparent pricing strategy will ensure the business gets a competitive deal.

Q: Who uses factoring?

A: Many companies use factoring to help accelerate cash flow. A business-to business company generating invoices with payment terms may be good candidate for invoice factoring. Industries using factoring most frequently include:

• Staffing
• Distribution
• Facility Services
• Manufacturing
• Transportation
• Consulting
• Food & Beverage
• Wholesale
• Professional Services
• Textile & Apparel
• Oil & Gas
• Janitorial Services

Q: What will my customers think about factoring?

A: According to the Global Factoring Market 2016-2020 report, analysts expect factoring to grow over 10% annually for the next several years. With more companies utilizing invoice factoring, it continues to grow as a necessary and responsible way for financing a business. Understanding the manner and circumstances in which the factoring company will communicate with the business’s customers is important. As long as the communications are professional and in line with the business’s message, customers don’t typically have any issues.

 

questions about factoring

 

Q: When do companies use factoring?

A: Companies utilize factoring as a cash flow accelerator in many circumstances. A few of the most common uses include to:

• Purchase inventory or capital equipment
• Invest in marketing
• Meet payroll
• Meet tax requirements
• Obtain better payment terms by paying faster

Q: Why use factoring over other types of financing?

A: Factoring helps businesses accelerate their cash flow and secure financing in a debt-free manner. The sale of the business’s invoices funds the growth, so the business owner maintains control and doesn’t have to give up any equity or ownership. With factoring, the availability of cash keeps extending and growing as your business expands.

Q: Is factoring the same as a loan?

A: No, factoring is not a loan. The business does not incur debt. The business sells its accounts receivable (invoices) to the factoring company.

Q: Can a start-up business use factoring?

A: Yes, a start-up business may be an ideal candidate for invoice factoring. While traditional lending options often require two years of operating history and a track record of profitability, factoring provides greater flexibility.

Q: Will personal credit issues restrict a business owner from using factoring?

A: No, personal credit issues alone won’t keep a business from being approved for a factoring partnership. A host of factors go into the credit decision, with the most weight on the credit quality of the business’s customers. Some business owners using factoring have experienced bankruptcy, tax liens and other financial circumstances that make traditional lending options difficult to secure.


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Is Invoice Factoring the Same as AR Financing?

Does your business need financing to grow or improve cash flow? If so, invoice factoring and accounts receivable financing may be options you’re exploring. A tremendous amount of information exists online, but the viewpoints often prove more confusing than helpful. Many financing and factoring companies use the terms factoring and accounts receivable financing interchangeably. In this post, we’ll address the similarities and differences of factoring and accounts receivable financing as we see it. For a quick overview, see the Financing Product Comparison table.

What is Invoice Factoring?

In a previous post, we define invoice factoring as a type of commercial finance that converts outstanding invoices into immediate cash. Factoring serves as a reliable alternative to a line of credit and helps businesses who:

  • Face slow-paying customers
  • Experience seasonality
  • Want to grow and expand
  • Want to launch as a start-up

How Invoice Factoring Works

In factoring, a business sells its invoices to a third party factor. The business can choose which invoices it wants to factor. The business presents a schedule (most often daily or weekly) to the factoring company detailing which invoices to factor. Then, the factoring company immediately advances a pre-determined percentage (typically 70-90%) of that total invoice value into the business’s checking account. Once the debtor pays the invoice under the payment terms, the factoring company pays out the remaining invoice amount less a small administrative fee. Thus, invoice factoring is an ideal financing solution for a business not wanting to wait 30,60 or 90 days for their receivables to roll in.

What is AR Financing?

Accounts receivable (AR) financing also uses outstanding invoices to fund growth.  Like invoice factoring, AR financing serves as another alternative to a traditional line of credit and helps businesses who:

  • Expect steady growth and expansion
  • Experience seasonality
  • May not be in a position for a traditional bank loan, but working towards it

How AR Financing Works

In accounts receivable financing, a business sells all of its invoices to establish a borrowing base. Similar to a traditional line of credit, the receivables line operates as a revolver. So, in AR financing the receivables are pooled.

Similar, Yet Different

Both invoice factoring and AR financing benefit businesses by providing funds in advance of collection. When cash flow timing matters most, both of these financing options quickly put money into the business. In addition, both offer professional credit services and receivables management.

The main difference between invoice factoring and AR financing lies in the underwriting criteria of the deal structures. While factoring offers greater flexibility, AR financing has more strictness around the credit profile. Consequently, AR financing typically offers preferred financing terms.

Answering Your Questions

Here at The Southern Bank, transparency defines our approach. If you’re like most of our customers, getting straight forward answers and understanding the detailed financial implications to your business are key factors in your financing decision. We explain and clarify along the way so you aren’t left wondering what you signed up for. Researching partners and need a question answered? Contact us and get your questions answered today.


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Switching Factoring Companies

As with any financing relationship, make it a priority to understand your exit strategy options with your factoring company. Before you enter into the relationship, ensure you know the steps to take and associated penalties in case you need to break the contract.

Switching your financing partner to another factoring company may be beneficial in situations including:

• Better pricing found elsewhere
• Unsatisfactory level of service with current funding partner
• Desire to switch to a partner with expertise in your industry

In the event of an early termination, several factors you’ll need to be aware of include: length of agreement, auto-renewals, window for notification, early termination fees and other penalties associated with terminating.

In addition to exit terms, we’ll be taking a closer look at three other important areas of an invoice factoring agreement in separate posts: float, fee structure and notice of assignment.

Length of Agreement with a Factoring Company

A one (1) year term is the most common length of an invoice factoring agreement. However, terms lasting as long as two and three years exist with some factoring companies. A shorter term equates to more flexibility. For optimal flexibility, don’t agree to terms longer than one year.

Auto-renewal and Window for Notification

The length of agreement (term) also becomes a factor with the auto-renewal clause. Most factoring agreements automatically renew for another subsequent term without termination notice. For example, if your two-year contract expires in June of 2017 and you miss the window for notification, you are automatically locked in for another two years or until at least June of 2019.

Know your auto-renewal date (typically the date the contract was signed). More importantly, know the window for notification. Two to three months is the most common window for notification, but longer lead times do exist. Mark the notification date on your calendar and have a conversation with your factoring company. By not giving notice, you will automatically be locked in for another term and will not have an opportunity to reevaluate your position and negotiate a better deal.

Early Termination Fees by Factoring Companies

Setting up the relationship requires time and resources by the factoring company at the onset, so it typically takes the contract term to recover those costs. Factoring companies ensure they cover these costs by imposing early termination fees.

A simple and common early termination fee is calculated as (monthly minimum fee X the number of months remaining in the term). Look for these variables to be outlined in your invoice factoring agreement. Another calculation could be (monthly minimum volume X a pre-determined percentage). Crunch the numbers before signing your agreement to understand what an early termination would cost.

Summary

To recap, when you sign an agreement with a factoring company:
1. Remember a shorter term is best, don’t sign multi-year agreements
2. Know your notification date and set up a calendar reminder to review the agreement each year
3. Understand how much it would cost to exit your agreement early in case you find yourself wanting to go with another partner

 


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