How An Invoice Factoring Transaction Is Structured

Invoice factoring is a form of business financing that has been gaining a lot of notoriety in recent years. It is a specialized form of business financing that is designed to help companies that offer net 30 to net 60 terms to their customers, but can't afford to wait that long to get paid. Factoring invoices solves this problem by advancing funds to companies based on their slow paying invoices. This improves their cash flow and helps them stabilize operations, allowing them to grow.

Most factoring transactions are structured as the purchase of an invoice by a factoring company. The purchase is done in two installments. The first installment is called the advance, and is provided as soon as you sell the invoice to the factoring company. The percentage that is advanced is based on your industry, your track record, the payment record of your customer and market risk conditions. Most advances average 80% of the invoice. However, transportation companies using freight factoring can get advances as high as 90%. Likewise, staffing companies can get factoring advances that go as high as 90%.

The second installment, called the factoring rebate, is paid to you once the customer pays the invoice in full. The rebate will include the remaining amount that was not advanced, less any fees. For example, if the advance was 80%, the rebate will be 20%, less any factoring fees.

When a factoring company purchases an invoice from your company, it can do so with recourse or without recourse. In a recourse factoring transaction , the factoring company has the right to sell back to you any invoices that have not been paid within 90 days, regardless of the reason for nonpayment. A non recourse transaction is a little bit different. The factoring company will absorb the loss of a non paid invoice if (and only if) your customer does not pay the invoice due to a declared insolvency (such as a bankruptcy) during the purchase period. Each factoring company engineers transactions in their own way, so you should familiarize yourself with the terms of your contract.

One very important aspect of a factoring transaction is the notice of assignment. Before you start factoring invoices for a particular customer, the factoring company will need to setup the customer. This is usually a fairly quick process where the factoring company checks your customers commercial credit, and then notifies them that their invoices will be factored. The notification letter, commonly referred to as a notice of assignment, informs your customer that you are working with a factoring company, who is helping you with your receivables. It also contains a new payment address. Many times the payment can continue to be made in your company's name, provided it goes to the new address. The notice of assignment is fairly standard in the factoring industry but each factoring company has its own version of it.

Although factoring transactions appear to have many moving parts, they are fairly simple to implement and can be easily integrated into most companies. One of its most important benefits is that factoring is flexible. The line is dynamic and tied directly to your sales. You can easily grow your financing - as necessary - provided you sell good products or services to a diverse number of credit worthy customers.