There are two groups of business professionals. If you are reading this, you are in one of the two groups. The first group, has no idea what invoice factoring is and the second group, do. So in order to put everyone on even keel, let’s go through the basics of factoring, then look at the reasons why invoice factoring makes good business sense.
The Nuts and Bolts of Invoice Factoring
The process of factoring involves three parties. The first is the Company, who manufactures goods or services and sells them to another party. The second party to the transaction is a the Client. The Client is the one who purchases from the Company and is the one that the company invoices. The third is the Factor, who purchases the Invoice that the Company issued to the Client. In the transaction the Factor my purchase the Invoice on a full recourse or no recourse basis and sometimes, somewhere in between.
Another issue is the difference between full or partial recourse and no recourse. The recourse here refers to how the Factor treats a default by the Client. In every transaction, there is a possibility that the Client fails to pay the invoice. Assuming that the invoice has been duly assigned by the Company, the Factor has one of two options. If it’s a non-recourse transaction, the Factor has no recourse against the Company, but can sue the Client for the face value of the invoice. The assignment gives the Factor legal right.
In the case of a recourse Factoring, the Factor, simply recovers its loss from the Company when a particular client defaults on an invoice. As one would suspect, the cost between the recourse and the non-recourse is different. The non-recourse cost is higher as the counter party risk is absorbed by the factor.
Good Business Sense
Most companies sing the praises for factoring because it’s a way to unlock the cash in the accounts receivable and put that cash to work rapidly. If that cash is tied up in the Client’s hand during the credit period, that does not serve the company any good. However, that is the obvious benefit. The additional benefit to factoring is that it does cut down on costs if you can have a policy where the entire receivables section of the firm is outsourced to the Factor. Having someone full time to deal with Client’s credit issue can get expensive.
Most customers are going to ask for a credit period and to approve this you need a dedicated department to handle it. If you outsource this to the Factor, you get a two for one deal, because every time you get a client you can submit it to the Factor for approval and if they are approved, then you can take them on. The benefit of having the Factor run the credit is so that you have professional credit evaluation handling the job.
In the event the Factor turns the Client down, you have a good excuse to have the client pay you on delivery and still maintain your public relations. In most cases the Factor does a very good job in ferreting out poor paymasters.
This way the Factor has two functions, first keeping your on hand cash balances high and filtering your clientele based on good credit. Both are desirable outcomes. This is why having a Factor makes good business sense.