Factoring

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January 30, 2008

The Basics of Factoring

By Brian Solomon, TMCnet Web Editor

The origin of the word "factor" is in the Latin "factare"—which means "to make or to do". This financing mechanism dates all the way back to the time of Hammurabi, and has been a basic building block of all trade.

Essentially, the concept refers to the sale or assignment of a sale, trade, or accounts receivable account for immediate cash. It provides businesses with access to quick cash and improved cash flow for expansion--without diluting equity or incurring debt.

The reasons for taking advantage of factoring are numerous and varied. For one thing, it allows businesses to take enjoy trade discounts or other early payment options with suppliers or vendors. It also offers the ability to re-invest immediately to acquire new sales opportunities.

The factoring firm assumes the credit evaluation risk of accounts receivable that may translate into decreased internal costs for accounts receivable administration, which means more efficient and effective customer accounts collection and better information for management on the credit worthiness of the firm's clients.

Increased working capital turnover is another benefit, as well as a reliable source of immediate financing. Other options may not be available or timely. The essence of the transaction is the credit worthiness of the particular receivable account, so long as the firm has aggressive sales efforts and marketing strength. Regardless of the stage of development, immediate cash could be available.

Factoring, however, is not a collection system for bad debts or slow pay accounts, but it may tend to speed the payment from an otherwise slow-pay client once the disciplined techniques of a qualified factor are introduced.

All variables come together in a "risk evaluation" cost rate or fee for the factoring service. The greater the perceived risk, the greater the cost. The range for the first 30 days might be between 2% and 7% of the gross value of the account financed.

The business in question must evaluate its own needs and requirements, including all actual or potential advantages, and the costs of the transaction. Factoring, if properly utilized, can be a valuable financial tool for achieving expanded sales and company growth.

Not all factoring companies are alike. In fact, they often vary greatly in terms, conditions and rates, depending on your firm's needs and accounts receivable.

Brian Solomon is a Web Editor for TMCnet, covering news in the IP communications, call center and customer relationship management industries. To see more of his articles, please visit Brian Solomon’s columnist page.