Factoring or Accounts receivable factoring is a creative financing option that works for most businesses. A company might use factoring, a form of finance, to cover its short-term cash needs by selling its accounts receivable (invoices) to a third party.
Factoring is the selling of a company’s accounts receivables, at a discount, to a factor who then assumes the credit risk of the account debtors. This is an innovative method for generating quick business capital that any business can do if they have accounts receivables to factor.
In some cases, the factor will buy a receivable for up to 90% of the invoice. The factor then receives cash from each of the debtors as they settle their accounts. Factoring is a great way to pull out cash that is tied up in your receivables. When the cash is tied up in this way it can really slow down a business and prevent quicker growth. If a business obtains the cash quicker through factoring they can also avoid paying back a high interest bank loan, or credit card account.
If you need capital now, and you do not have time to wait for your customer’s credit terms to expire, then factoring could be a wise choice. The creditworthiness of your customers plays a big role in determining the types of rates you will get. Factors do not like it when they cannot collect on a receivable that they purchased.
The positive of relying on your customer’s creditworthiness is that for start-up businesses this is an excellent form of capital for a company that has not established their corporate credit history yet. It is also great because large forms of collateral are not needed to secure loans.