How Factoring Effects the Balance Sheet

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Factoring actually improves the balance sheet by converting accounts receivable into immediate cash. Until recently, the average invoice on net-30 day terms was taking about fifty-four days to be paid. When there was a downturn in the economy, the average went from fifty-four to about fifty-nine days. When a business submits a new invoice to a factor, it takes about twenty-four to twenty-six hours.

A balance sheet improves with factoring because the question of when the company will benefit from the payment of an invoice is eliminated with an immediate advance on the invoice. It is much more predictable to plan on factoring than other variables such as the effects of the economy. The amount of time it takes for another company to pay an invoice can be effected by the economy as well as other variables.

Even though banks and other conventional loan institutions use a UCC-1 filing to tie up company assets, accounts receivable are not considered the most secure for backing up a loan. Generally there are other assets considered more secure as collateral.

But a factor only ties up only accounts receivable and not other equipment as collateral. In fact, factoring is not a loan but the sale of an asset. So it enters the balance sheet as cash rather than as a loan.

In difficult times, companies have used credit cards to finance material and operational costs rather than conventional loans. However, the burden of paying off the credit cards is difficult due to their clients paying late on invoices. One of the nice features of factoring is not having to make periodic payments. Furthermore, the amount of money available grows automatically as the business grows. There is no need to apply for an increase in the line of credit.

Factoring is similar to receiving payments from credit card companies. When Company A buys from Company B, a credit card company pays Company B in full minus the discount almost immediately. A factor pays a percentage almost immediately and the reserve minus the discount once the invoice has been paid in full. So a credit card company pays in one installment whereas a factor pays in two installments.

Factoring is more expensive than taking out a conventional loan so it should be considered a time sensitive and a transitional way of financing a business. Some Fortune-500 companies have used factoring as a way of growing their companies and becoming successful. It is a viable alternative when a company is growing but not yet able to qualify for adequate conventional funding.

Company executives should always keep in mind that the number one reason for failure in business is from a lack of available funding. They should always understand the time value of money. Cash flow is extremely important when a company is growing.

An example of how factoring works is as follows: Company A delivers products and/or services for Company B for $1,000. The invoice is submitted to the factor. The factor immediately sends Company A $800. After company B pays the invoice in full, the factor sends Company A $200 minus a discount. (Perhaps $20-$30 for a thirty day period)

Another flexibility of factoring is delayed submission of invoices to the factor. If it is more advantageous for a company to finance customers for the first thirty days and factor only the invoices not paid within the thirty days, the company can factor only those invoices. Furthermore, the business does not have to factor all of the invoices.

Only the companies invoicing business to business or business to government are eligible for factoring. It is also possible to factor purchase orders particularly if the company is selling products rather than services. In some cases, it is possible to finance the purchase orders and invoices.

Factors have a tendency to specialize in an area of their expertise. Some factors only do medical factoring. Others do construction. Yet others specialize in manufacturing and distribution. So it is important to have a broker who can match the right factor with a business needing factoring in a particular industry. Usually the percentage of the advance on construction invoices is only about seventy-percent due to nuances in the construction industry such as liens, subcontractors, tier subcontractors, retention etc.

The whole purpose of factoring is to increase cash flow in order to help a business grow. It is possible to grow only when there is adequate cash flow.