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Factoring
Factoring: an example of how
factoring works.
Smith's Gadget Co. is a growing business, manufacturing and selling
gadgets to other businesses. Mr. Smith generates an average of
$100,000 in invoices each month. His customers always pay their bills,
but usually in 30 to 60 days. Mr. Smith realized that if he had the
cash earlier, he could take advantage of his supplier's discounts for
early payment and discounts for volume purchases. This would allow him
to fulfill orders quicker, increase production and sales, thus
increasing profits.
Mr. Smith decided to sell, to a factor his $100,000 of receivables
each month. Mr. Smith submitted the application and a list of
customers that he wanted to factor. The factor's initial paperwork,
including "due diligence", usually takes 10 -14 days to
complete. (His customers' credit was discreetly checked.)
Upon approval, Mr. Smith submitted invoices to be factored, the factor
verified that Mr. Smith had delivered the goods or services invoiced,
and that his customers are satisfied with the product. Then, within 24
hours, the factor advances $70,000 to $80,000 by wire transfer
directly into Mr. Smith's bank account. The factor then waits for Mr.
Smith's customers to pay the invoices.Once the invoices are paid to
the factor, the balance of the $100,000 is paid to Mr. Smith, minus
the fee the factor
charges to wait on the invoice payment.
Now that Mr. Smith's Gadget Company is factoring, 70-80% of their
invoices are being paid within 24 hours. Now Mr. Smith is using the
accelerated cash flow to grow his business faster than ever.
Factoring: benefits to the business owner.
While factoring can certainly benefit businesses with cash flow needs,
there are many reasons a business owner should consider factoring.
1. Elimination of bad debt. A non-recourse factor will assume the risk
of bad debt, thus eliminating this expense from the business' income
statement.
2. Invoice processing. Factors handle much of the work associated with
processing invoices, including posting invoices to a computer system,
depositing checks, entering payments in the computer and producing
regular reports.
3. Offer credit terms to customers. With factoring, businesses can
offer credit terms (or extended credit terms) to their customers
without negatively impacting their cash flow. The business can grow by
making it easier for customers to buy from them.
4. Unlimited capital. Factoring is the only source of financing that
grows with sales. As sales increase, more money becomes immediately
available. This allows the business to constantly be able to meet
increasing demand.
5. Take advantage of early payment discounts and volume discounts. If
a business can save 2 - 5% of their raw materials cost because they
have the cash to pay within ten days, this significantly reduces the
true cost of factoring. Coupled with the ability to make volume
purchase with the cash advances, they will likely save even more
money.
6. Stop offering early payment discounts to customers. Since companies
that factor receive their money immediately, they don't need to offer
early payment discounts. Factoring will save every dollar in discounts
that customers were taking. By
realizing this savings and taking advantage of the early payment and
volume purchase discounts, the business owner may be able to offset
the cost of factoring.
7. Don't give up equity. The business owner does not have to give up
any equity in the company (as is usually required with venture
capital) or take on any partners, with factoring.
8. Don't incur additional any debt. Factoring is not a loan and
therefore the business is not incurring any additional debt.
9. Detailed management reports. The factor provides detailed
management reports allowing for better management of cash flow.
10. No geographical limits. A factor can work with a client in any
part of the country and that client can have customers all over the
world.
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