Factoring (also known as invoice factoring) has gained popularity as a growth area with new potential revenue streams for financial institutions. Factoring is a transaction where a financial services company (the factor) buys accounts receivable invoices from various companies that, for cash flow purposes, would prefer to receive a discounted amount upfront rather than wait for their customers to pay later.
The factor gives the company a discounted price for their invoice, which is calculated based on the industry, invoice details, the company’s credit rating, the track record of invoice payments for this company, etc. There is often an additional percentage paid when the factor collects payment of the invoice if paid on time, with the remainder netted as profit.
For example, there is an invoice due of $10,000. The factor buys it from the holder for $8,000. Upon collection of the invoice from the customer, the factor pays out another $1,500 to the owner, netting a profit of $500. If the customer pays their invoice after the due date, a sliding scale would typically be applied to the reserve to compensate the factor.
Factoring is a niche market that can serve both sides well. The factor is able to earn a profit by assuming the risk over time, while the holder gets money up front, and does not have to worry about the accounts receivable and debt collections aspect.
To mitigate some of these risks, the factor may add fees for higher credit risk customers, those with a poor payment history, number of days it takes to pay, etc. And, since a common stumbling block for new factoring enterprises is having the capital on-hand to buy the invoices, another method utilized is re-discounting the invoices.
Re-discounting involves the factor essentially re-selling the invoices to a third party (usually an investor), at a discount. This provides the factor more liquidity and purchasing power, while greatly reducing their liability.
Factoring is essentially a collection service that can be mutually beneficial for two or three parties. MIMICS now offers a Factoring software system to handle all of your operational needs. Please contact us for more information or to view a demonstration.