Debt factoring is a financial transaction in which the accounts receivable of a business is purchased as a means of obtaining immediate money from those receivables. Businesses that are in need of finances quickly sometimes use this approach, rather than relying on the typical cash flow situation that exists with their clients. When arranged to the benefit of both parties, debt factoring can be a useful tool to help a company move forward. In order to make sure the arrangement is beneficial, both the lender and the borrower must agree on a few key points: the factoring process, the factoring fees, and the terms of the contract that governs the business relationship.
Typically, debt factoring involves the lender purchasing a batch of invoices and extending a partial payment for the face value of those invoices on the front end. Many companies provide anywhere from 80% to 90% of that face value up front. Payment is usually made directly into the debtor’s bank account within two to four days after receiving the details on the batch of invoices. Businesses that are considering debt factoring as a way of generating quick cash flow should seek to obtain the highest up front payment possible.
There is also the matter of the factoring fees. Most lenders will retain a small percentage of the face value of the purchased invoices as payment for their services. Depending on the lender’s terms, this fee may be anywhere between three and seven percent of the batch’s face value. Here, the goal of the debtor is to secure the most competitive fee structure possible, so that eventually a greater amount of the face value of the invoices is received by the debtor.
Careful scrutiny of all the terms and conditions related to the debt factoring agreement is crucial to the success of the business funding relationship. Along with the policies regarding payouts to the debtor and the amount of the factoring fees, debtors should be aware of any additional charges or fees that could apply, including charge-backs on invoices that are not paid by the debtor’s customers within 90 days. The process for ending the working relationship should also be considered very carefully, so that there is no misunderstandings if and when the debtor chooses to stop using the factoring and wishes to regain control of the company invoicing process. In addition, understanding the collection procedures of the lender is essential, if the debtor wishes to avoid what could be awkward situations with his or her clients that could lead to a loss of customers and the revenue they generate.
