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What is Factoring?

Factoring is a form of financing where a business sells its accounts receivable to a financier known as a factor. Once a business sells its accounts receivable, or invoices, the business immediately receives cash for a percentage (70-80%) of the invoice. The remainder, less the financier's fee, is paid to the seller when the full invoice payment is received and cleared by the factor.

The following example shows how simple factoring really is.

Consider a software development company who has just delivered $100,000 of software to a major computer manufacturer. Instead of waiting the typical payment period, which could be 90 days or more, the software company could factor the invoice with Hamilton and receive between $70,000 and $80,000 within 24 hours. This cash could then be used to fund a marketing campaign for a new software release, or simply pay off some outstanding debt. As soon as the computer manufacturer remits payment, and the payment is cleared by Fluehr Craft National Network, the software company will receive the remaining value of the invoice minus the factor's fee.

Factoring on the Financial Spectrum

To firms desiring financial flexibility, factoring fills the void between traditional bank credit and equity participation. Banks remain the option of choice for the cost sensitive borrower. However, for businesses with few assets for collateral or a weak statement of cash flows, bank financing is usually unobtainable. If it can be obtained, the business owner must be prepared to endure restrictive terms, covenants, and guarantees.

At the other end of the spectrum, equity capital remains the most expensive option. That is, assuming the business owner is able to attract a venture capitalist or other private investor. Given the effects on business ownership and profit sharing, businesses never stop paying for equity capital. Furthermore, business owners may encounter untimely demands for repayment, as well as unwelcome or meddlesome equity partners.

Financial Spectrum

Positioned firmly in the center of this continuum is today's factor. Factoring increases cash flow without any debt obligation (good for your balance sheet) and is generally shorter in term. Thus, factoring can be far more flexible with fewer restrictions and covenants than bank financing. And, because factoring does not seek to establish an equity position with clients, ownership dilution and buyouts are not an issue. Factoring is not dependent, as banks and other investors are, on the financial soundness of the business, instead factors look at the soundness of the business's customers and their ability to pay.

For start-up businesses that lack impressive financials or businesses that do not want to enter restrictive agreements and long-term commitment, factoring can be a desirable financial tool to increase cash flow.

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