Continuous Cash Flow

Wednesday, August 4

Factoring?? Never Heard of it.

Over the past fifteen years, growing numbers of small and mid-sized companies have begun to explore factoring as a practical source of working capital. Unfortunately, the availability of accurate, up-to-date information has not kept pace with the mounting interest in this much under-utilized form of commercial financing. We therefore present the following discussion for those seeking a broader understanding of this dynamic alternative to traditional debt/equity funding.

What is Factoring?

The term "factoring" refers to the outright purchase and sale of accounts receivable (A/R) invoices at a discount from their face value. The structure, terms and conditions of such a transaction may vary in any number of ways, as evidenced by the array of factoring programs currently available throughout the United States.

Companies engaged in the business of buying accounts receivable are called "factors." Factors often exhibit a flexibility and entrepreneurial awareness rarely demonstrated by banks and other secured lenders, whose activities are more generally restricted by regulation and prevailing law.

Companies selling their receivables are typically referred to as "clients" or "sellers" (not "borrowers"). The client's customers, who actually owe the money represented by the invoices, are generally known as "account debtors" or "customers."

Characteristically, there seems to be no industry-wide term of art to describe the actual event that occurs when a factor accepts invoices for purchase. Common terms for this event include: "schedule," "funding," "advance," "assignment" and "transaction."

The cash which a factor issues to a client as initial payment for factored invoices is typically called an "advance."

Factoring differs from commercial lending because it involves a transfer of assets rather than a loan of money. In assessing risk, therefore, factors look primarily to the quality of the asset being purchased (i.e. the ability to collect client receivables), rather than to the underlying financial condition of the seller/client. This focus makes factoring a suitable vehicle for many growing businesses when traditional commercial borrowing proves either impractical or unavailable.

Defining Accounts Receivable

In the factoring industry, the term "accounts receivable" normally refers to short-term commercial trade debt having a maturity of less than 90 or, at the outside, 120 days. To be sure, factors sometimes receive offers to purchase longer-term debt obligations, such as leases or commercial notes. The purchase of such debt instruments, however, does not fall within the meaning of the term "factoring" as it is most commonly used.

Factors are universally quick to distinguish between invoices (which represent legally enforceable debts) and purchase orders (which do not). Most factors refuse to advance money against purchase orders under any circumstances. A few, however, have developed separate purchase order financing programs.

Similarly, factors generally refuse to purchase "pre-ship" invoices that clients sometimes generate prior to shipping goods or providing services to account debtors. Many factors will immediately terminate a factoring relationship if they discover that their clients are attempting to factor "pre-ship" invoices.

[Hope this clears up a few things. After you request the e-doc give us a call with any questions you may have.

Download the full e-doc titled "The Basics of Accounts Receivable Factoring"

Copyright 1997 The Edwards Research Group, Inc. All Rights Reserved. Excerpted and Edited.