This form of finance is called factoring. Say your company (the client) provides a product or service to a customer, then issues an invoice for those goods or services. The customer frequently takes 30-90 days to pay the invoice. Rather than wait, the client can sell the invoice to a third party, called a factor. The factor will verify that the invoice is valid and that the customer has the willingness and the ability to pay.
The factor will pay for the invoice in two parts. Initially, he will pay the client an advance of typically 70-80% of the face value of the invoice. This usually takes less than 48 hours. When the customer pays, the factor will deduct a fee, and refund the balance to the client. This fee is mostly affected by the time the invoice is outstanding.
There are numerous advantages to factoring for a client company. The most obvious one is that cash flow improves immediately. Factors also provide other benefits as part of their normal business, such as handling collections and tracking accounts receivable. A factor can provide quality assurance when they verify that the customer received the product. Another benefit is that a factor will verify a customers’ credit before advancing funds. If you’re looking to do business with a new customer, but the factor won’t fund their invoices, you will want to be very careful about the terms you offer them.
Factoring rates tend to be higher than bank rates, but when considering costs it’s important to consider the benefits as well. Having cash on hand to bid more work or take advantage of supplier discounts can make a huge difference. The objective is to make more money by factoring than you would if you didn’t factor.
Factoring has changed a great deal over the last ten years. There are 5-10 times as many funding sources now as there were then, so rates and terms are much more competitive. There are factors for invoice volumes of $500/month to over $10 million/month. There are factors of all sizes who specialize in the construction and medical industries.
Because there are so many funding sources, your best bet is to use an independent broker. Most brokers don’t charge any client fees. They are paid referral fees by the funding sources because the funding sources are wonderful people (many of them are very nice, actually) and because it’s less expensive for them than advertising. There is very little difference in referral fee rates between different funding sources, so finding the best match between the needs of the client and the funding source is the primary concern.