Factoring is the purchase of accounts receivable at a discount. This means that a factor is a person or business that pays immediate cash for business receivables.
Why would a factor do this? Well quite simply, an unpaid invoice that will be paid by a financially strong company has value. Factors pay cash for the right to receive the future payments on client’s invoices to their customers.
It must be noted that factoring is not a loan where interest would be due, but it is the sale of an asset. This is a very important distinction.
So how much does factoring cost and how does it work? The answer to this question varies greatly depending on amongst others the following:
1. The volume and size of the invoices
2. The type of invoices
3. Who the invoices are billed to and how financially strong they are
4. How long it takes for the customer to pay the invoice
A typical transaction might look like this: An invoice for $100 might be sold to a factor. He will advance 80% against the invoice initially and then pay the balance of the invoice when the invoice is paid by the customer (less the small discount fee). This means that initially the client would get $80, and even more money once the invoice has been paid. The factor keeps a small fee in exchange for facilitating the transaction.