Factoring as a finance option for small businesses
One of the major challenges facing small businesses is how to raise funds to meet short term funding gaps in business. Such funding gaps may include financing of job orders, funding of inventories for further production or clearing cost of imported items.
A sure way to get bank fund for short term finance is to discount invoices (or receivables) for good already supplied or jobs already executed in favor of reliable principals. Most especially now that blue chips and large conglomerates employ suppliers credit as their own funding option. Most principal will not make payment to suppliers until after 90 days or more after suppliers invoices have been verified.
Articles were written earlier discussing Short Term Loans which includes LPO Finance, Contract Finance and Invoice Discounting as a Short Term Loan options for businesses. Factoring which is a way of delegating your receivables to someone else (Lender) is another way of getting funds from your bank on invoices or receivables that have been verified by your principal.
The Wikipedia defines Factoring as “a financial transaction and a type of debtor finance in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. A business will sometimes factor its receivable assets to meet its present and immediate cash needs”.
Factoring is way of “selling” your invoices to a lender (Factor) at a discount. The principal (or debtor) may or may not be notified of the arrangement with the lender but has made agreement with the borrower to pay at a scheduled date. The payment date is a major consideration in determining what amount will be charged on the invoice by the lender (bank).
While both Invoice Discount Finance and Factoring (delegation of receivables) requires that job must have been concluded or good sold to a principal or debtor while payment is being expected, Invoice Discounting Finance is a formal loan arrangement where you use your invoice as a collateral to obtain a bank loan , Factoring on the other hand is not a loan arrangement, it is a way of getting funds by selling your invoice or receivables to a lender at a discount. it requires no collateral and no bogus loan documentations.
Factoring is widely used in international trade by exporters who while waiting for its international client to receive goods and make payment (depending on the arrangement) use this funding arrangement to raise fund for his business and in manufacturing for businesses who needs to replace inventories while waiting for sales proceeds.
Application of this type of loan arrangement for small or retail businesses will only be useful if the borrower or businesses have clients that the lender or Factor is comfortable with. Thus only few businesses in Nigeria that have blue chips and multinational as their principals can approach the very few bank that offers this finance options for their customers.