Factoring of receivables is an arrangement whereby a company sells its accounts
receivables to another company (banks and other institutions) that specializes in
buying them and obtains the necessary financial accommodation. It is the most
popular method of short-term financing in the US.
Factoring offers the following advantages: relief to manufacturers and sellers from
the bother of collection of book debts, saving in time and man-power required for
debt collection, and last but not the least, adequate and better source of financing.
The factoring institutions render the following functions: Credit recording- that
involves maintenance of debtor’s ledgers, collection schedules etc. Secondly,
there is Credit administration that includes the collection of debts. Thirdly,
there is credit financing, whereby the factor advances money against receivables.
Finally, there is finance and business information wherein advices are given to
customers on current trends and challenges.
Commercial paper is an important money market instrument, which is in the form of
unsecured promissory notes issued by firms to raise short-term funds. Certain
conditions are to be satisfied before the issue of commercial paper. Permission
should also be obtained from the credit rating agencies. Commercial papers
are issued for a period ranging from 3 months to 6 months. Commercial paper
offers alternative source of raising short-term finance, helpful in times of tight
bank credit and is a cheaper source of finance.
Term loans are those loans that are extended for a specific period ranging from
1 to 15 years. Medium term loans are extended for a period of 5 years and
long-term loans are granted for a period of 15 years. Term loans are granted
for establishment, renovation, expansion and modernization of industrial units as
well as meeting the requirements of core working capital and for repayment of bonds
and preference shares. Term loans are usually secured. They have either
a fixed or a floating charge against the assets of the company. They are granted
on the basis of a formal agreement, which contains the terms, and a condition of
providing loans.
Factoring is a way to increase your cash flow without going into debt. A Factoring
Company will purchase your accounts receivable (invoices) as soon as 24 hours after
you invoice; this creates immediate cash flow for your company.
Factoring Companies are usually more flexible than traditional lenders regarding
requirements needed to qualify for funding. Since Factoring Companies collect
directly from your customer they are more interested in the customer’s credit history
than yours, and are often willing to fund new companies.
Factoring Loans vs. Bank Loans
Is factoring a type of loan?
No. Even though invoice factoring is commonly referred to as “factoring loans”,
it is a financial practice involving a B2B transaction, but no bank.
To further explain, account factoring, it is when a company, purchases your accounts
receivable invoices at a discount and provides you with immediate cash. A
traditional bank loan uses your company’s accounts receivable as collateral, where
account receivables factoring looks primarily at the financial soundness of your
customers, not your company. Banks are regulated heavily; large finance companies
generally are public and driven by pressures in the financial markets. When
times are tough, banks and finance companies limit lending. A small business,
too new to have a track record, with a weak balance sheet, with a history of financial
problems, in turnaround mode or undergoing big changes, often cannot find a willing
lender at any price. That is why factoring is best for small to mid-sized
businesses.
Does a bank loan make more sense for my small business than invoice factoring?
No. Banks often have restrictive lending requirements relating to cash flow, profitability,
equity, and years in business, which prohibit them from making loans to small to
mid-sized businesses. Since factoring companies are not in the lending business
and there is really no such thing as “factoring loans”, the decision to purchase
invoices is influenced primarily by the quality of your customer base and their
financial stability, and not the financial fundamentals of your company.