Factoring also known as Invoice factoring is not a line of credit. It provides the funding needed for rapid growing companies. By the sale of your company’s receivables (invoices) to turn them into immediate operating working capital at a discount. It also operates as a line of credit. In the sense that it fluctuates based on your company’s sales but the way it is structured is completely different. Non-recourse factoring lines operate just as a revolving line of credit with a bank. But, instead of having a predetermined maximum amount for available funds, it fluctuates depending on your company’s sales and creditworthiness of your clients. It serves the purpose of funding your company and providing the needed working capital to continue your company’s operation.
Differences between Line of Credit and Factoring
Here are some notable differences between a factoring line and a traditional bank line of credit:
- Factoring companies depend mostly on the creditworthiness of your clients (account debtors) to be able to provide funding. Instead of your company’s financial performance and creditworthiness. On the other hand, banks base their decision mostly on your company’s sales history. And, performance (balance sheet, cash flow and profit and loss statements) as their main criteria to determine the size of the line they are willing to offer your company as a client.
- Factoring transactions are recorded in your company’s books as cash (assets). Once the invoice is sold on a true basis. As opposed to a bank line of credit where the transaction must be recorded as debt. Your company’s cash flow is their source of repayment and you and your company are responsible to return the funds plus interest. In factoring transactions the funding depends on the creditworthiness of the account debtor (your client). And repayment comes directly from your customer by paying on your invoices directly to the factoring company.
Due Diligence Process
- A line of credit with a bank is usually dependent on the shareholders’ personal credit score. And it usually requires you as the owner and your partners to sign a personal guarantee. Banks usually decline deals for companies with individuals that have poor credit scores. Non-recourse factoring facilities do not necessarily require a personal guarantee. In most cases factoring companies do not run personal credit scores as part of their due diligence process. Since their main source of repayment is the account debtor (your client) and not your company.
- A due diligence process at a bank can take 2, 3 or 6 months for a facility to be approved. The same due diligence process should not take more than 5 to 7 business days with a reputable factoring company. Quick funding is one of the value propositions offered by factors to clients demanding immediate working capital for growth purposes. Speed is key in certain industries and factors can accommodate to those demands within their operating guidelines.
Advantages of Factoring
- A good factoring company will provide customized and flexible solutions to accommodate the needs of its clients. By always offering personalized service and the overall customer experience to be pleasant. Banks tend to offer very rigid and bureaucratic decisions and service. There is usually nobody to depend on for a particular request that would make a huge impact at certain stages of growth in your business. At good factoring companies you will be serviced by a specialized account executive. They will take care of your invoice confirmations, fundings, collections and overall reports of your account.
- Bank lines of credit require a minimum of 2 year track record of business. Tax returns reporting healthy profits to be qualified as opposed to factoring. That is suitable and beneficial for start ups and companies with limited history. But a strong business plan and industry experience.
- Non-recourse factoring companies not only provide funding but also credit coverage for the account debtors (your clients). Also, in case something goes wrong with them (i.e. bankruptcy). Some of the other added values of good factors are: market intelligence, industry expertise and guidance towards the success of your business.
In the U.S, factoring has been used mostly by small and medium sized businesses. With annual sales between $500,000 to $30,000,000 in industries such as: apparel, transportation, oil & gas, staffing, seafood, aviation, manufacturing, import/export and food & beverage distribution. With no access to traditional bank financing yet or with higher working capital demands. That a bank is willing to support especially during early stages of the business. However, factoring can be used by any business wanting to unlock their accounts receivable. And, convert them into cash to be able to continue operating and growing their business.
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