Working capital factoring allows companies to sell invoices and receive a percentage of the balance immediately, with the factoring company collecting payments directly from customers. This can provide cash flow and save time on collections. It is a viable financing option for businesses without access to a line of credit.
Working capital factoring is a business service that makes it possible for companies to make use of working capital sooner rather than later. Often referred to simply as invoice factoring or advance, this strategy makes it possible for a company to effectively sell the invoices for a recently closed billing period and begin using a significant percentage of the balance on those invoices immediately. The buyer of the invoices receives payments directly from the customers who receive the invoices, thus paying off the debt in full. Companies that use working capital factoring often take this approach for several successive billing cycles and may enter into a permanent working arrangement with a factoring company.
The process associated with working capital factoring is quite straightforward. The factoring service assesses the stability of a prospective client and examines their average accounts receivable for the past few months. This allows the service to get an idea of how long it takes customers, on average, to pay invoices once they are received. Most factoring services prefer situations where the change in invoices is between thirty and forty-five days after issuance.
Assuming the accounts receivable are acceptable, the factoring service will purchase the invoices issued for the last billing period. At the time of purchase, the customer is provided with a percentage of the face value of those invoices, generally between eighty and eighty-five percent. Once the invoices are paid in full, the factoring service pays the remaining balance to the customer, less than three to five percent of the total face value of the invoices. That three to five percent withheld is considered the fee for providing the working capital advance to the client.
There are several benefits to working capital factoring. The most obvious is that the issuer of the purchased invoices receives cash now and not later. Along with this benefit, most factoring services take care of the collection process. This means that the issuer no longer has to maintain staff or spend time on those efforts. Depending on the size of the clientele and the average response time in paying outstanding invoices, these savings can be significant.
Businesses that are not in a position to establish a working capital line of credit with a bank may find that working capital factoring is a viable financing option. Assuming the collection processes used by the factoring company are in line with the client’s customer service ethic, the relationship is likely to be productive and friendly. Before actually committing to any factoring situation, it is imperative to understand exactly what is required in terms of compliance and how the collection processes will be handled. Doing so will help to avoid any unpleasant situation that could lead to losses in the customer base.
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