The Basics of Accounts Receivable Factoring

Invoice factoring is a useful tool in acquiringFactoring fee: This is the cost to the client for the
much-needed working capital for businesses of anyservice and is usually expressed as a percentage of
size. Even though factoring volume continues to growthe receivables factored per 30 days. The fee can
each year, many business owners and financialbe anywhere from 2% to 4.5%, depending on the
executives aren't aware of this form of financing.perceived risk of the account.
This article explains some of the major componentsDue diligence: When a company applies for factoring,
of accounts receivable factoring.the funding source performs an investigation to:
Factoring is the sale of a company's business to(1) determine if there are liens on the receivables in
business accounts receivable at a discount forquestion,
immediate cash. Note that the services rendered or(2) validate the information contained in the
products sold must be to creditworthy businessapplication, and
customers,not to individuals.(3) check the credit of the client's customers.
Important accounts receivable factoring terms:Subordination agreement: As stated above, the
Advance rate: The amount of cash the factoringfactor must have a "first position" on the receivables.
company gives the client, expressed as a percentageIn other words, they have the right to receive
of the invoice totals. Advance rates are typicallyproceeds from the receivables in the event of
between 70% and 85%, depending on severaldefault as a result of a blanket lien on the A/R. When
factors such as the overall credit standing of theanother entity already has a lien on the receivables,
customers and the type of industry the client is in.the factor will require the bank, taxing authority or
Factor: The factor is the funding source for factoringindividual to release the encumbrance. The legal
transactions. Most of these companies are onlydocument that accomplishes the lien release is called
involved with factoring and similar services such asa subordination agreement
purchase order funding.Debtor notification: At the inception of the factoring
Reserve: This represents the total amount of therelationship, the factor sends a letter to each
invoices factored less the amount advanced by thebusiness customer of the client. The letter explains
factoring company. The reserve is remitted back tothat the company has entered into an agreement to
the client upon collection of the invoices less themanage the company's accounts receivables and that
factoring fee.future payments are to be made to a new address.
Letter of Intent: After the factoring company hasThe debtor sends payments to a lock box that is
received the application and other documents fromcontrolled by the factoring company.
the proposed customer and it appears that they canSpot factoring: Most factoring contracts require a
work with this client, a letter of intent is issued. Theminimum amount of factoring volume per month
LOI specifies the proposed terms of the relationship,from the client. But there are other niche factors that
subject to due diligence.allow the client to factor invoices only when needed.
UCC filing: The only collateral for a factoringThis type of funding is called spot factoring.
relationship is the business receivables, so theThese terms are important to understand before
factoring company files what is called a blanket UCCentering into an agreement with a factoring company.
filing to protect its interests. When they make a UCCThe contract, which is typically for a year in length,
filing, they have a lien against the company'sshould be thoroughly studied before signing on the
receivables in the event of bankruptcy.dotted line.