As a business person, selling to customers on credit often helps to boost sales, but what do you do when the payments are yet to come in and you need cash to handle several tasks and activities such as salary payments or purchases? This is where factoring comes in.
Factoring refers to selling the value of the credit your customer owes even before they pay. How is this even possible? You can do this by entering an account retrievable in your business books while awaiting the payment date.
The difference between factoring and the accounts retrievable financing you are familiar with is that factoring entails selling the accounts receivable and not borrowing against them. When you sell your invoices, you get cash immediately, which improves your business cash flow.
Understanding the concept of Accounts receivable
On one hand, account receivable refers to sales yet to be paid for in cash. On the other hand, it is also an investment as it is currently unavailable to be spent on activities like loan repayment, bill payments, and business expansion.
In summary, it is a lack of liquidity, which can exist even in the presence of profit. For instance, when you bag a contract with the government, it can bring massively increase your business’s profit. However, the payment often takes several months. In this situation, you should implement government contract factoring to help you secure an advance on unpaid government receivables.
When dealing with factoring government receivables, you will be selling your invoice to the government, thereby removing some things from your balance sheet and putting it on the business sheet of the factor company.
The factor company that buys your receivables will take the titles to the invoices in question, and then collect the funds when they are due to be paid. The same company will take responsibility for the debt collection process and all related costs.
Advantages of Factoring for small businesses
As far as your business is concerned, factoring offers several advantages, including:
Meeting your cash needs quickly
Factoring helps you to get payments quickly so that you can get money in real time to handle activities that need them. When you have a business relationship with a factoring arrangement, you can be assured that the turnaround on your receivable sales will only take about a day.
Avoidance of Debt
Factoring is debt free because it is a sale of an invoice and not a loan. So, whether you don’t want to take a loan, or you don’t qualify for such loans, factoring helps to provide alternative financing.
No responsibility for collections
In most cases, the factoring agreement you reach with the factor company is one where the company takes over all rights in the invoices, including the responsibility for handling debt collection. This is called non-recourse factoring.
However, in some cases, recourse factoring might be applicable whereby you have secondary responsibility for uncollected invoices. If a situation occurs where the factor company is not able to recover the entire debt in question, you take responsibility for the remaining uncollected debt.