Today it is very common for a company to offer their customers credit as a payment option. While the benefits gained from providing this alternative are great, there are also some drawbacks. The primary disadvantage is that a business must wait for a period of time before receiving their money. Depending on the company’s specific circumstances this arrangement can create a financial hard ship. A solution to this problem is for a company to begin factoring their account receivables.

Factoring is the process of selling invoices to a 3rd party in exchange for an immediate source of funds. This 3rd party will then assume the risks and payments associated with the invoices. This practice always carries an associated cost.  A business that chooses to sell it’s invoices is charged a fee which is based on a number of elements. Chief among these factors are: the credit worthiness of the customers who have been billed, the amount of the invoice, and the length of the invoice agreement. Additionally, a company may receive a price break if they sell the invoices in “bulk quantity”.

So how does a company know if it makes sound financial sense to participate in factoring their account receivables?  It is necessary to determine if the benefits that are gained outweigh the cost of the fee. Let’s take a look at a typical example.