In the course of running businesses, it is not uncommon for there to be some debt that may be beyond that company or business entity to repay. That may call for some external intervention. Factoring companies are one sure way of handling such a debt. But just what is factoring? What is the best factoring business model?
We are here to help you get sorted out with this issue. In our conversations that follow, we shall peek into this subject matter from just about any other angle that may be deemed plausible. Specifically, we are going to examine all the steps and the details that pertain to it.
What Is Factoring?
For one, factoring is a way of helping a company that is debt-trapped to stay afloat. In this instance, another company or financing institution comes to the rescue of the debt-ridden company by way of purchasing the debt instruments. Common examples of these invoices are the debentures or the invoices.
In the course of this transaction, the company that is bailed out will often have to part with some fee as soon as the debt instrument is fully settled. It is a common way of mitigating the harmful effects of adverse debt and also enable the affected firm to operate smoothly and clearly.
How Does Factoring Work ?
There is no universal method or stage via which this instrument is undertaken. Nonetheless, there are stages that the typical factoring exercise goes through. Here, we delineate these stages for you and explain just what transpires in each stage for you to know how to go about the same.
Call for Help
A distressed company will usually be the first to call for help. This is something it can do openly or privately. If the company chooses the open approach, it has to place an advert in a leading daily and invited interested firms to bid. In case it chooses the private approach though, it will directly channel the call to another private company to seek the necessary help and support.
Shortlisting the Firm of Choice
Most firms usually choose or prefer the public approach as it is the surest way of garnering the most reliable debt financiers. With this approach comes the many bidders who will basically be jostling for the limited slot. This being the case, the company in debt has to sieve through the many applications and shortlist the ultimate winner.
This is ordinarily an elaborate exercise that entails closer scrutiny of the companies that have made it to the top. It often involves examining the financial standing of the companies that have bid, their previous track record in bailing out other companies, any existing legal disputes, and so on.
Assessment of the Extent of Debt
The company selected to carry out the bailout will now embark on assessing the extent of the debt of the affected company. This entails examining the debt in question, assessing its worth in absolute terms, the collaterals that were placed against the debt, and the dates due for the repayment.
It is not uncommon for the debt terms to be also renegotiated at this stage. The processes will usually also incorporate the closer scrutiny of the invoices and the bank statements as well. After this, the bailout company weighs the same against its financial strength.
At this stage also, the factoring company verifies the invoices that are to be used as collateral in the whole process. Along with this are the tax lien search, judgment search, uniform commercial code liens, and the Dun & Bradstreet search. The overall purpose is to comply with the laid down legal regimes as possible.
Agreement on a Payment Structure and Schedule
After the above stage, both the financier and the affected company shall embark on drawing up a payment structure. A payment structure is the breakdown of the installments in which the debt shall be paid. The schedule on the other hand is the time-frame within which the debt instruments are to be finally settled.
Purchase of the Debt Instrument
The above is followed by the actual settlement of the debt claim. Here, the financing company remits the payments within the stipulated timeframes. These payments are channeled to the stipulated accounts and copies of the receipts furnished to the company under the debt obligation. Of course, they have to be made strictly within the allotted timeframe.
Repayment of the Debt
After some time, the company that is bailed out has to repay the debt to the financer, definitely. That has to happen within an agreed-upon timeline and pursuant to the remission of a similarly agreed-upon interest or surcharge. In the event of the failure of the company to do so, the collateral is often forfeited.
Factoring Flow Chart
A typical factoring business goes through the steps delineated hereunder:
Serve your Clients
You submit invoices
Factor Verifies the Invoices
Receive a Cash Advance
The Factor Collect Payments
The Factor releases the Reserve Amounts (minus the applicable fees)
Types Of Factoring
There are many kinds of factoring techniques that the companies may pursue in the course of handling their debt burdens. In this segment, we take a look at some of them and explain their relevance to the business transactions.
- Recourse Factoring
- Non Recourse Factoring
- Secure Factoring
- Unsecure Factoring
Scope Of Factoring Business Model
Factoring may be used in certain areas and segments of the typical business setting. In this segment of our discussions, we take a look at some of these areas and what each of them typical entails:
Accounts Receivable Factoring
In this case, the debt-ridden company sells its accounts receivables to the financier or the factor. The factor, in this case, collects the payments that are due for the receivables from the customer of the company. This method is mainly preferred by the companies that want to accrue some quick cash without having to wait for too long to do so.
If a company wants to offset some debt it accrued in the course of transporting some goods, it may opt for the transportation factoring. In this sense, the factor pumps some money to offset the debt or facilitate the delivery of the goods to the designated locations without having to wait for too long.
Invoice Factoring for Freight Brokers
Are you a freight broker who wants a quicker turnaround and unimpeded inflow of cash? You may have to opt for the invoice factoring for freight brokers. This form of debt bailout negates the need for you to wait for too long to receive the cash you want. That is because it cuts down the waiting time for the shippers to settle their dues.
Government Invoice Factoring
Governments have a very bad reputation for being slow at remitting their dues. This may not always augur well for smaller businesses whose survival largely depends on a quick flow of liquidity. To bridge this gap, the business concerned may have to resort to the debt factoring of the government invoices.
Purchase Order Factoring
Just like the government invoices above, the purchase orders also promise to remit the payments due at a certain future date. They too may not always be honored promptly, a fact that may not always go down well with the small businesses. A purchase order factoring steps in to bridge this gap and furnish the necessary liquidity.
Trucking Invoice Factoring for Trucking Companies
Trucking companies generally have to wait for too long to receive their dues. That stems from the similarly slow nature of the business and the reduced turnovers. Owing to the fast-moving nature of many businesses we have, it may not always be prudent or wise to wait for too long to receive the dues.
Medical Bill Factoring
Medical expenses for a large part are through the roof. Moreover, such expenses are often incurred by way of emergencies. As such, the affected parties are often too slow to remit the dues, a fact that may not always be convenient to the companies concerned. Medical bill factoring comes to bridge this gap by furnishing the necessary liquidity.
Factoring in Banking
Banks are perhaps the worst affected companies by the menace of bad debt. To stem this tide, banks have to rely a lot on the issue of factoring. In this sense, the banks sell their debt instruments to the other financiers, typically larger banks to have their debt liquidated and converted to cash.
Credit Card Factoring
Credit cards rely heavily on debt. They are used to finance projects and the purchase of items that are way beyond the scope and the reach of the people who would like them. Because of that, they are for a large part heavily affected by defaults and bad debt. Factoring comes in to remedy this by converting the debt to liquidity.
Small Business Factoring
The survival of small businesses is largely dependent on the quick flow of money. Such businesses can never have to wait for too long to receive their pays from their clients. They hence have to rely heavily on factoring as a way of staying afloat and guaranteeing the cash inflows.
Freight Bill Factoring
It is a way of financing businesses in the transport industry. In this case, this instrument helps the brokers and the carriers to up their flow of money typically by financing their invoices. The factor basically provides the liquidity that the freight company requires until such a time that the clients remit their dues.
Factoring Broker Training
A broker is a go-between, a firm that exists to facilitate the transactions between two or more parties. They too have to engage in serious training to help them to stay afloat and manage their finances. One sure way of managing this is to train their staff in the matters of factoring.
Below is a table that endeavors to break down the costs of each of the types of factoring above:
Factoring Software Solution
By far the surest way of factoring the debt is to use a dedicated piece of software for that matter. This is a specially designed computer program that handles the tasks and the stages of the process outlined above. Most of these pieces of software are further attached to a cloud to store the data and make for easier retrieval thereafter.
Though there are many kinds of software you may tap into at the moment, Comarch Factoring is by far the most recommended for the job. It grants the factors and their clientele the power to manage and take full control of the life cycle of their receivables.
Also, it provides all the customer care tools that the various parties to the deal may leverage to up the performances of their businesses. With this piece of software, it is also possible for the parties to undertake advanced settlements and gain access to numerous channels for debt settlements.
Disadvantages Of Factoring Business
Though this mode of the business transaction has many advantages, it is not without its own share of potential downsides. Here we go now to the disadvantages of factoring in business.
This form of business financing only serves those kinds of debt that are smaller and short-term. Many factoring companies often shy away from that debt that is too large and takes too long to recover. As such, it may not always serve every other instrument that may warrant intervention.
May Trigger Unauthorized Access to Client Base
In the course of following up on debt due, the factor has the leeway to contact the client base of the debtor. This may usually give rise to the unauthorized start of relationships between these two parties. That of course may boil over to the long-term engagements that may ruin the profitability of the business concerned.
To factor the debt is a labor-intensive undertaking indeed. The stages involved in a typical factoring process is often too laborious to handle. With that also comes the wastage of time that may have to be expended to actualize the procedures. Not many people have the patience and the stamina to go through the entire process.
The task of factoring debt is incomprehensive in the sense that it may not always handle every aspect of a firm that may warrant some intervention. You still have to look up to other firms and business entities to have your issues fully sorted out. These may include debt restructuring or employee rationalization.
As hinted above, the task of factoring the debt is ordinarily costly. The factor demands some fees for stepping in, to the rescue of the firm that is affected by the debt menace. Also, in case the client’s default in remitting the dues, the collateral that was issued is forfeited, a fact that may serve to deepen the woes further.
International Factoring Assosiation
International factoring is largely applicable in international trade. In this instance, the factor facilitates the trade and the debt instruments within two or more countries. The process entails selling or assigning the outstanding receivable of a buyer in another country to the factor in the host country.
The organization further aims at providing information, resources, purchasing power, and training to the factoring community on a global scale. It also endeavors to offer further assistance to the members of this wonderful trade by addressing every issue and problem they may have to contend with, in the course of their operations.
Its membership is open to all banks and other financial companies that handle the matters of financing and factoring. In case disputes arise in the course of settling these dues and debts, the association also yet again comes in to solve and arbitrate them. Thus, it acts as an umpire in the course of such transactions.
Our long and in-depth look into the subject matter of factoring companies comes to an end there. Having done the much we can, we now defer the matter to you to take over from where we have left. That cannot mean anything else save for you now to consider enrolling in such a scheme yourself.
There is never a better time to do that. Waiting for too long to venture into such a business may only serve to give your competitors the free hand to venture in there themselves. That will definitely lock you out or diminish your chances of ever getting a foothold and operating profitably later on.