Monday, May 01, 2006

PROCESS: How Factoring Works!

Here is a simple example to demonstrate how the factoring process works. You have a million dollar, three-month contract with XYZ Corp. that you are starting. (You have provided all the information on the contract and on XYZ to your factoring company and this particular customer has been approved for financing.)

You complete your service or deliver your product and send out the first invoice of $100,000 to your customer; at the same time you fax a copy to your lender with a request for financing.

Your lender gets in touch with your contact at XYZ and verifies that the invoice is in line with the contract and will be paid.

At this point, your lender wires the advance on that invoice to your bank account, based on the advance rate previously agreed upon. For example, if your advance rate for this contract is 80 percent, you will receive that percentage of the face value of the invoice. In this case, that would be $80,000 (80 percent of $100,000). Now you have this money in the bank to pay employees, vendors, whatever you need the money for. The factoring company then waits on payment while you concentrate on completing the next stage of the contract. In other words, focus on running your business and not worrying about cash flow.

When XYZ Corp. pays the invoice, they send the check for the full $100,000 to the “lock box” (P.O. Box) of your factoring company. (The check can still be made payable to your company.)

Your Factor retains the $80,000 originally advanced to you, and then sends you the 20% minus all fees and interest to your bank account.

Note that you do not have to finance every invoice that you send to XYZ Corp. If, toward the end of the contract, your cash flow improves, you can notify the lender that you are not requesting financing on certain invoices. This is just one example of the process; each factoring company has its particular methods and qualifications.

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Thanks for reading!

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