Businesses are constantly required to give credit to their customers, while they continue to need to pay bills for materials, salaries and administrative expenses. This leads to a problem with cash flow, and is a major reason for the failure of poorly managed businesses. While deep pockets can address this issue, there are other solutions besides bank borrowings that can help to ease cash flow problems.
Accounts receivable factoring is once such solution, which involves selling the accounts that have to be received, to an investor and receiving money from them, at a cost, without having to wait for customers to pay up their dues. It is a process that has been in use by entrepreneurs for thousands of years, and allows businesses to prosper and grow, through the billions of dollars that such financing brings in to business.
An account receivable is an unpaid invoice which has value, which the customer has agreed to honor in the future, because of the credit extended by the business supplying the product or service. Credit card companies use this form of accounts receivable factoring, by paying merchants immediately a customer has made a sale. For this they charge the merchants fees, while the customer is allowed time to pay the money.
Factoring can offer a lot of benefits to companies, which have problems with their cash flows. Businesses offer credits of various periods to customers for products that are delivered to them. The business has already incurred the cost of production of these items, through materials, labor, administration, financial, and sales expenses. When the business approaches investors or lenders who have the necessary capital, they can get cash immediately by offering a discount on the amount of the invoice.
This helps a business to pay its own suppliers and staff so that the process of production is never halted. This form of factoring does not have to be restricted only to the manufacturing sector, and can be used by any business that offers credit on its sales. It is a process that is very fast, and once investors or lenders, are sure that a business has been discriminatory in offering credit to customers who are creditworthy, further factoring can become a regular part of the business and its financing.
Many businesses consider factoring as a cost of doing business, and one that is far easier and cumbersome, than applying for loans from financial institutions. They factor it into their sales price and are therefore, quite comfortable, in offering the discounts, in order to obtain the cash they need for their business. It is of great help to companies that have just started, and who have yet to build up a credit, that can allow them to get loans easily. They still need to be careful in their own sales strategies and offer credit only to customers who can be relied on for payment in the future. Factoring discounts are often much lower than interest rates charged by lenders, and do not have to figure in balance sheets, like loans will have to.