This type of factoring is by far the most widely practiced. Upon taking title to invoices, the factor immediately pays to the client a percentage of their total face value. This payment (called the "advance") typically falls between 70% and 85%, but may go as low as 50% or less (for example, in the case of construction or third-party medical invoices), or as high as 90%. After successful collection of payment from the account debtors, the factor subsequently remits the balance of the invoice amount(s)(usually called "the reserve") to the client, minus the factor's earned fees.
Thereserve provides the factor with available funds from which to draw its fees, and furnishes a buffer against defaults by clients and/or account debtors.
Some factors do not hold back a reserve balance, but rather advance the entire invoice face value, less maximum factoring fees, at the time of purchase. This practice is not widespread, however, since most factors of this type prefer to retain the protection that reserves offer.
Advance/reserve factors generally structure their fees as an initial discount rate (typically ranging between 1.5% and 5% of invoice face value), followed by subsequent increases scheduled over the length of the actual collection period.
Thecollection period begins on the day that the factor advances funds to the client
(which is not always the same as the invoice date), and is normally divided
or "time bands" of equal duration. Windows most typically occur in
although 7-, 10- or 30-day increments are not unheard of. The initial discount
normally increases by one or two percentage points at each new window.
So, why not simply go over to the friendly banker for a loan to alleviate cash flow problems? A loan can be difficult if not impossible to receive, especially for a young, high-growth operation, because bankers are not expected to decrease lending restrictions soon. The relationships between businesses and their bankers are not as strong or as dependable as they used to be.
The impact of a loan is much different than that of the factoring process on a business. A loan places a debt on your business balance sheet, which costs you interest. By contrast, factoring puts money in the bank without the creation of any obligation. Frequently, the factoring discount will be less than the current loan interest rate.
Loans are largely dependent on the borrower's financial soundness, whereas factoring is more interested in the soundness of the client's customers and not the client's business itself. This is a real plus for new businesses without established track records.
There are many situations where factoring can help a business meet its cash flow needs. It provides a continuing source of operating capital without incurring debt, which can result in growth opportunities that dramatically increase the bottom line. Virtually any business can benefit from factoring as part of its overall operating philosophy.Every good businessperson must understand the concept and benefits of factoring in order to operate as profitably as possible. The following chart can help you understand the differences between factoring and other sources of funding
What is Accounts Receivable Financing?
Receivable financing, also known as factoring is a method used by businesses to convert sales on credit terms for immediate cash flow. Financing accounts receivable has become the preferred financial tool in obtaining flexible working capital for businesses of all sizes. The receivable credit line is determined by the financial strength of the customer (Buyer), not the client (The seller of the receivables).
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