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The Ins and Outs of Factoring

Factoring is a business financing tool that refers to the purchase of an invoice by a factor at a discount so that the business, in turn, accelerates cash-flow or minimizes credit risk. It is a tool that has been around for decades.



Small Business Working Capital Learning Topics:



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Cash: Better to Have In Hand Than Out of Hand

Factoring invoices, in concept, is quite simple. It's about having cash in hand today versus at some later date.

Factoring centers around managing accounts receivable. When your business sells a product or service to a customer on credit, an invoice is created. The invoice represents an accounts receivable. The customer is then responsible for paying the invoice at a later date when it becomes due. In short, your business has put up money and resources to complete the sale, yet does not recover the cost of goods sold - and hopefully a profit - until a later date when the customer actually pays.

Factoring offers a way for you to get paid sooner rather than later by selling the invoice to a third party referred to as a factor. The factor buys the invoice at a discount, which may range from 1% up to 3% of the normal commercial invoice's face value depending upon a range of factors. At the time the invoice is bought, the factor pays you anywhere from 70% – 85% of the total invoice amount. The remaining balance is paid to you, minus the factoring fee (the discount), once the factor collects the full amount from the customer.

By having the cash in-hand sooner rather than later, you can use it for other purposes. Therefore, while the discount actually represents an additional cost in the sales transaction, the cost is typically minimal compared to making your money work for you sooner.

Factoring Invoices vs. Accounts Receivable Financing

Factoring is different from Accounts Receivable Financing. With factoring, the factor purchases your commercial invoices and pays the company a discounted value of the total amount of the invoice. With Accounts Receivable (AR) financing, the value of the total AR amount is assessed and a loan is made to the company in a comparable amount with the AR serving as collateral.

Did you know?

"...that 1st PMFBancorp® specializes in invoice factoring and has helped thousands of businesses over the past three decades to improve cash flow? The benefits for your business in using accounts receivable (AR) financing are clear and direct. By outsourcing your invoice management to 1st PMFBancorp, you can free up collection resources to focus on other more profitable activities like marketing and selling your products. In addition, you can access working capital, enabling your business to overcome the problem of having the majority of your cash tied up in AR or inventory."



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Other Small Business Working Capital Learning Topics:
Working Capital Know-How | Factoring | Alternative Financing | Increasing Cash Flow | Special Finance Services

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Note: This information has been compiled by the Knowledge Institute for Small Business Development (KISBD) for educational purposes only in order to convey a general overview of the options and related services available to small businesses in the subject areas introduced. Content is provided on an "as is" basis and is not intended to be an exhaustive representation, nor does it provide advice or create a customer relationship between KISBD and its sponsors, buzgate.org, its affiliates and any other organization named herein, and any reader.

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