A business practice used in England since 1400
Factoring is a type of debtor finance in which a business sells its debtors (i.e. invoices) to a third party (called a factor) at a discount. Usually the debtor is notified of the sale of the receivable, and the factor, bills the debtor and makes all collections. Factoring debtors provides immediate cash to a business to meet its present and immediate cash needs.
Factoring as a business practice has been used in England since 1400, and came to America with the Pilgrims, around 1620. In Australia factoring provides over $63.3 billion of finance annually to businesses.
Factors generally provide their clients with four key services:
- Advancing funds to rapidly growing businesses.
- Information on the creditworthiness of prospective customers. This is instantly available online.
- An outsourced credit function. This is done in real-time online.
- The operation of the debtor’s function. This eliminates the need and cost for permanent skilled staff.
Factoring is normally used by fast growing companies to fund their working capital needs. Freeing up the cash tied up in the debtors allows these businesses to fund their inventory and operating costs. By reducing the size of its cash balances, more money is made available for investment in the firm’s growth.
With factoring a business can get an upfront cash advance of between 75% and 90% of its debtors. Advances are usually made within 48 hours giving a business access to quick cash. The costs of factoring include a set fee on the invoice and then an interest rate based on how long the funds are drawn for. This ranges from 0.60% to 2.50% of the invoice amount and between 8% and 14% per annum on the drawn funds balance, depending on the limit amount, turnover, etc.