Borrowing money from your bank using uncollected bills from your clients as collateral is called debt factoring. This is a process by which a business can get to use money that is owed to them before they collect the debt or credit. Usually it is done with thirty and sixty day bills. It is also done with bills that are signed by your good clients.
Factoring is like a loan but you will not pay interests on it, you will be charged a small fee for each factoring operation that the bank accepts to do. There is one important issue that you must not forget; your bank is not buying debt from you.
It should not be used to pay your own bills or your business bills, if you need it for that it may be a good time to take a look at your company’s financial condition. Your company should be able to pay for its own bills out of the money they get as a profit. The same thing goes for you, you must pay your debts with the, money you get as a salary.
They have an advantage over local factoring though. When you give an international company credit on goods and services they must provide you with collateral in the form of a Bank Guarantee or a Standby Letter of Credit that guarantees your payment on a specific date. This payment is guaranteed by the bank issuing the instrument. The factoring company’s money is safe protected by the financial instrument.
They are not running any risks because the banking instrument guarantees their money and therefor the commission you are paying them. You on the other hand are getting the money that you need to replenish your materials and product reserves, you will lose a small percentage by paying the factoring entity. You would lose much more if you did not have any product to sell.
Most banking instruments are acceptable for factoring. Many of them are issued by strange little banks from all corners of the Earth. These little banks have their own treaties with larger world banks which guarantee that the smaller banks paper is good and negotiable and so on and so forth are fortunes made in this world.
Factoring is an excellent tool used every day. Probably the company you buy from is also using it. Try not to abuse this privilege though. If you bring too many bad debts to the bank they will cancel your privileges. Use factoring when you need it, not just because you want the money in your hand.
Debt factoring is a way of stabilizing the cash flow in your business by the practice of invoice discounting. You get the advantages of revenue from sales immediately and avoid the hassle of bad debt collection.
