Invoice factoring is a useful tool in acquiring much-needed working capital for businesses of any size. Even though factoring volume continues to grow each year, many business owners and financial executives aren't aware of this form of financing. This article explains some of the major components of accounts receivable factoring.
The Basics of Accounts Receivable Factoring
Invoice factoring is a useful tool in acquiring much-needed working capital for businesses of any size. Even though factoring volume continues to grow each year, many business owners and financial executives aren't aware of this form of financing. This article explains some of the major components of accounts receivable factoring.
Factoring is the sale of a company's business to business accounts receivable at a discount for immediate cash. Note that the services rendered or products sold must be to creditworthy business customers,not to individuals.
Important accounts receivable factoring terms:
Advance rate: The amount of cash the factoring company gives the client, expressed as a percentage of the invoice totals. Advance rates are typically between 70% and 85%, depending on several factors such as the overall credit standing of the customers and the type of industry the client is in.
Factor: The factor is the funding source for factoring transactions. Most of these companies are only involved with factoring and similar services such as purchase order funding.
Reserve: This represents the total amount of the invoices factored less the amount advanced by the factoring company. The reserve is remitted back to the client upon collection of the invoices less the factoring fee.
Letter of Intent: After the factoring company has received the application and other documents from the proposed customer and it appears that they can work with this client, a letter of intent is issued. The LOI specifies the proposed terms of the relationship, subject to due diligence.
UCC filing: The only collateral for a factoring relationship is the business receivables, so the factoring company files what is called a blanket UCC filing to protect its interests. When they make a UCC filing, they have a lien against the company's receivables in the event of bankruptcy.
Factoring fee: This is the cost to the client for the service and is usually expressed as a percentage of the receivables factored per 30 days. The fee can be anywhere from 2% to 4.5%, depending on the perceived risk of the account.
Due diligence: When a company applies for factoring, the funding source performs an investigation to:
(1) determine if there are liens on the receivables in question,
(2) validate the information contained in the application, and
(3) check the credit of the client's customers.
Subordination agreement: As stated above, the factor must have a "first position" on the receivables. In other words, they have the right to receive proceeds from the receivables in the event of default as a result of a blanket lien on the A/R. When another entity already has a lien on the receivables, the factor will require the bank, taxing authority or individual to release the encumbrance. The legal document that accomplishes the lien release is called a subordination agreement
Debtor notification: At the inception of the factoring relationship, the factor sends a letter to each business customer of the client. The letter explains that the company has entered into an agreement to manage the company's accounts receivables and that future payments are to be made to a new address. The debtor sends payments to a lock box that is controlled by the factoring company.
Spot factoring: Most factoring contracts require a minimum amount of factoring volume per month from the client. But there are other niche factors that allow the client to factor invoices only when needed. This type of funding is called spot factoring.
These terms are important to understand before entering into an agreement with a factoring company. The contract, which is usually for one year in length, should be studied thoroughly before signing on the dotted line.
Kent Harlan has been a CPA since 1984 and is the owner of Ozarks Capital Funding, a company offering alternative financial solutions for business and healthcare providers. We can give you a free, no-obligation invoice factoring quote. Just fill out our online application to get started.
Contact information: - EMAIL: kent.harlan@ocflink.com
- PHONE: (800) 560-4420
- WEB: http://www.ocflink.com
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