Unlike most other financial products designed to help your company’s cash flow, factoring is not a form of financing through debt. Instead, it’s the sale of your invoices and the right to collect on them to a third party. Factors offer a discounted rate from the face value of the invoice to offset the costs of collecting, as well as the risk of default. The more you work with one service, the better calibrated your costs will be, because the factor will learn your customers’ payment habits to get a better picture of the actual risk they will default on payments.
Step by Step Factoring
It all starts when you apply to a factor. You can go with a service that asks you to submit all your invoices in a group or opt for one that asks you to pick and choose. Companies that factor all the invoices currently onhand tend to get a higher percentage of their total face value, due to risk dilution across the pool. You may also need to submit customer payment histories or other documents about your relationship to the companies invoiced, as well as basic financial information about your business.
Factoring agents then review the application package and calculate an offer for the invoices based on the perceived risk of default. You receive that percentage of the face value, and if the customers pay on time, usually also a back end payment of some kind after the factor collects. If the customer pays late, you may forfeit the back end payment on that invoice. Finally, you have to communicate to your customers that payments and balance inquiries go to the factor for the invoices you’ve submitted.
How To Lower Your Costs When You Apply
In addition to submitting all your invoices at once, there are a few ways to make sure you’re getting the best advance values from a factor. One is by reducing the payment windows you give customers after invoicing. This helps shorten the factor’s wait for repayment. Many companies also work with the factoring service to determine when customers with late payment histories become too costly to keep. Regular financing also helps lower costs when you submit all your invoices because it ensures a maximum age for the invoices, usually somewhere between four and six weeks for companies relying on the advances for cash flow injections.
Additional Cash Flow Management Tips
To get the most out of your advances from the factor, it’s a good idea to have a couple other cash management structures set up. Adding a business credit card for petty cash expenses or a credit line to handle overflow costs like inventory can provide additional working capital when you have a high demand for outgoing cash and a lot of new orders coming to make sure your cash flow works as well when things get busy as when they slow down.