Debt factoring allows businesses to obtain immediate cash from their receivables. The lender purchases a batch of invoices and pays a partial payment upfront, keeping a small commission. Careful scrutiny of terms and conditions is essential for a successful financing relationship.
Debt factoring is a financial transaction in which a company’s receivables are purchased as a means of obtaining immediate cash from those receivables. Businesses that need funding quickly sometimes use this approach, rather than relying on the typical cash flow situation that exists with their customers. When organized for the benefit of both parties, debt factoring can be a useful tool to help a business move forward. In order to ensure that the deal is beneficial, both the lender and the borrower need to agree on a few key points: the factoring process, factoring fees, and the terms of the agreement governing 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 at the front end. Many companies provide anywhere from 80% to 90% of that face value. Payment is typically made directly to the debtor’s bank account within two to four days of receiving details on the batch of invoices. Businesses considering factoring as a means of generating quick cash flow should try to get the highest possible upfront payment.
There is also the matter of factoring fees. Most lenders will keep a small percentage of the face value of bills purchased as payment for their services. Depending on the conditions of the lender, this commission can be between 3 and 7% of the nominal value of the lot. In this case, the debtor’s goal is to secure the most competitive fee structure possible, so that the debtor ultimately receives more than the face value of the invoices.
Careful scrutiny of all terms and conditions related to the debt factoring agreement is critical to the success of the business financing relationship. Along with policies regarding payments to the debtor and the amount of factoring fees, debtors should be aware of any additional fees or charges that may apply, including charges on invoices that have not been paid by the debtor’s customers within 90 days . The process for terminating employment should also be considered very carefully so that there is no misunderstanding if and when the debtor chooses to stop using factoring and wishes to regain control of the business invoicing process. Furthermore, it is essential to understand the lender’s collection procedures, if the debtor wishes to avoid what could be embarrassing situations with their customers that could cause a loss of customers and the revenue they generate.
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