How Does Factoring Work?
A potato chip company has purchased $100,000 worth of individual serving bags from Bob's Bag Company. The potato chip company buys from Bob's partially because Bob allows 60 days within which to pay for the bags ordered.
1) Bob ships the bags and issues an invoice.
2) A factoring agreement has already been entered into with Bob's Bag Company.
3) Bob sends the original invoice and shipping and receiving document to the factor.
4) The factor verifies shipping, receipt and that there is no merchandise problems.
5) Within 24-48 hours, Bob gets 70% of the face amount or $70,000.
6) The factor holds the balance in a reserve, or escrow account.
7) When the invoice is paid by the potato chip company, Bob receives the balance less the fee.
1) Bob ships the bags and issues an invoice.
2) A factoring agreement has already been entered into with Bob's Bag Company.
3) Bob sends the original invoice and shipping and receiving document to the factor.
4) The factor verifies shipping, receipt and that there is no merchandise problems.
5) Within 24-48 hours, Bob gets 70% of the face amount or $70,000.
6) The factor holds the balance in a reserve, or escrow account.
7) When the invoice is paid by the potato chip company, Bob receives the balance less the fee.
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Without factoring:
Sales 1 million 100% Cost of sales $600,000 60% Gross profit $400,000 40% Operating cost $380,000 38% Net profit $20,000 2% |
With factoring:
Sales 2 million 100% Cost of sales 1.2 million 60% Operating costs $600,000 30% Operating profit $200,000 10% Factoring expense $70,000 3.5% Net profit $130,000 7% |
The profit increase due to increased cash flow is normal because you now are utilizing your fixed assets more efficiently. Factoring works because it gives a company immediate cash thereby increasing the company's ability to purchase additional materials and labor which allows for increased productivity with the same capital base.
Factoring also has other benefits. The factor assumes responsibility for the collection of invoices. That relieves your accounting department of credit checks and provides customer follow-up when an invoice is due. It can mean operational savings of as much as 2 percent annually. And it allows every employee in an organization to concentrate on sales and production.
With factoring, you retain complete control and ownership of your company ... and you get the cash you need.
Factoring also has other benefits. The factor assumes responsibility for the collection of invoices. That relieves your accounting department of credit checks and provides customer follow-up when an invoice is due. It can mean operational savings of as much as 2 percent annually. And it allows every employee in an organization to concentrate on sales and production.
With factoring, you retain complete control and ownership of your company ... and you get the cash you need.