Bank Factoring Explained

What if there was a business financing vehicle that immediately reduced your company’s cost of capital, improved its cash flow and didn’t appear as a loan on your balance sheet. Does such a financing vehicle even exist? In fact, it does, and it’s known as bank factoring. Now, by no means is bank factoring new. It’s a form of business credit with a rich and storied history that goes back hundreds, if not thousands, of years. It is unlike any conventional form of business financing. It allows companies to use the liquidity within their existing assets in order to secure the working capital needed to fund their operations. What can your company expect once it decides to pursue this financing alternative?

Understanding factoring

Factoring works by allowing companies to use the liquidity of their current receivables as credit. They can draw upon the value of these receivables based on the age of the invoice and its value. For instance, once a customer is invoiced for their purchase, the company can immediately draw upon a portion of that invoice’s value and establish a working credit line with the bank. A portion of the invoice is advanced to the company. The bank then proceeds to collect on the invoice directly from the end customer. Once that invoice is paid in full, the bank reimburses the company the difference and charges a fee for the entire transaction. These fees are comparable to current interest rates. So, what are some of the immediate benefits?

  • Reduced cost of capital: Financing receivables is expensive. However, factoring alleviates this cost by allowing your company to gain access to cash faster. No more worrying about financing your customer’s business and no more worrying about them extending their terms.
  • Improved cash flow: Companies choose factoring because it immediately improves their cash position. Ultimately, it empowers them to manage their finances from a position of strength, and not one of weakness.
  • Greater flexibility: Access to immediate cash allows your business to buy the raw materials and finished goods so vital to maintaining your operations. If managed properly, your company could use the cash to secure early payment discounts from vendors and creditors, thereby further reducing your cost of capital.
  • Not a conventional loan: As mentioned, factoring isn’t a loan and therefore won’t appear as one on your balance sheet. However, it affords your company the opportunity to secure the financing so vital to your operations by allowing you to use the money as you see fit.

Companies of all sizes, and in all kinds of industries, have come to rely upon factoring as a means to supplement their existing financing. It offers a number of advantages over conventional loans and business credit lines. It’s easy-to-use and provides companies with the option of choosing which receivables to factor. This further increases the flexibility of this financing option. In essence, it’s no different than outsourcing a company’s receivables collection. Except in this case, your company is able to reduce its cost of capital and improve its cash position.