What is Factoring?

What is Factoring?: Factoring is the oldest form of banking out in the industry today. Factoring, receivables factoring or debtor financing, is when a company buys a debt or invoice from another company. Factoring is also seen as a form of invoice discounting in many markets and is very similar but just within a different context. In this purchase, accounts receivable are discounted in order to allow the buyer to make a profit upon the settlement of the debt. Essentially factoring transfers the ownership of accounts to another party that then chases up the debt. Client: The two parties that work with the 3rd party factoring company are the Client and the Debtor. The client is underwritten but the Debtor underwriting is weighed much heavier than that of the Debtor. The Client is the small business who completed the service or task and needs cash upfront to continue growing and make payroll, order new product etc… Debtor: The debtor is the company that received the services by the client provider. The Debtor is the security for the factoring line of credit. Underwriting relies heavily on the debtor’s ability to pay and past payment history. Advance: The advance is the percentage of the total invoice that will be paid to the client upon verification of the invoice. Once Debtor has paid the factoring company then the balance held by the factoring company will be released minus a very small percentage as a fee. Rate: There is always a rate to the client that will be charged as a fee. Depending on the length of time the invoice is out and the industry of the client and debtor the rate will go up or down. A factor rate ranges in normal circumstances between 1.5% and 3.5%. In some industries it can be even higher but generally not higher than mid-single digits. Reserves: The advance rate may be 85% of an invoice total. The reserve in this case would be the remaining 15%. Depending on industry the reserves can be released at the time the factoring company receives payment or it may be held over in some of the high-risk industries. It is still funds of the client but may be held to make up for a unpaid invoice or fees that are owed by a debtor. Documentation: The client will need to provide a list of debtors they currently work with as well as an aging summary. Insurance certificates will be verified in most industries as well as the corporate documentation from the client. A sample invoice from each debtor will be collected upfront and a full application from the client will be needed. Underwriting: Both the debtor and client will be underwritten although the debtor will most important. Third party credit reports, payment history, Dunn and Bradstreet report, tax search and a complete UCC1 check will be done and examined prior to factoring. Most instances this can all be done within 24 hours.