e most misunderstood financial tools available to small businesses today, in the United States alone, factoring dates back to colonial times. Historically factoring has been around for more than 4000 years, or since the beginning of trade and commerce. In the U.S. a popular method of financing, factoring is helping many businesses improve their cash flow. Simply put, factoring is when a company decides to discount its accounts receivables, at which time the factor bears the credit risk for the accounts. Itis the factor who is the recipient of payment from the client’s customer. Invoice factoring is among one of the most efficient forms of financing today — particularly now that we are faciong such tough economic times. Factoring has been traced back to a king in Mesopotamian named Hammurabi. Historical documentation about the use of factoring proves that it took place in our American colonies before the American Revolution. This was at a time when raw materials like furs, cotton, timber and tobacco were shipped to Europe. Merchant bankers in London and other parts of Europe advanced funds to the colonists for these raw materials. this way the colonists were able to continue to harvest their new land, free from the burden of waiting to be paid later by their European customers. This practice of receivables factoring was very helpful to the colonists, as they could go ahead and begin their harvesting without waiting for the money the Europeans owed them. In the past, factoring agreements were on an all or nothing basis where one either factored all of a company’s invoices or not. But in recent years, single invoice factoring, also known as spot factoring, has become popular. With single invoice factoring, you are allowed to factor as few or as many invoices as you desire. Perhaps you own a small business and things are going really well, but you wish you could get some additional working capital to move your business to the next level. Whether it’s a one-time need, or an ongoing necessity, working capital or the lack of it, is the most obvious reason between the success and failure of a small business today. Factoring just might be the ticket for you and your company? Ask yourself if your small business could use factoring to speed up cash flow. If you need to increase working capital so the business can grow, then chances are you could use factoring. While often confused with accounts receivable factoring, which is another way of saying invoice factoring, accounts receivable financing technically refers to a loan agreement between two parties. Factoring is a financial purchase or transaction and involves three parties. The biggest difference is that with a loan it’s your credit that matters, with a factoring agreement it’s your customers credit worthiness that matters. You may hear things like accounts receivable factoring with and without recourse. What does this really mean? The term “spot factoring” is the same thing as single invoice factoring and it is becoming more common in its usage. Single invoice factoring, or spot factoring, refers to the increasingly popular practice of picking your spots, or choosing which invoices you want to factor. This allows you to retain the most money while spending the minimum fees with the factoring company.

Thanks to Kristin Gabriel for contributing this article to our Factoring blog:

Invoice Discounting

The only thing more destructive to business survival than lack of customers is lack of cash flow to produce goods and provide services in a high demand market. Consistent cash flow is the lifeblood of commerce and the catalyst for healthy economies. There are many options available to increase cash flow.

Factoring, also known as invoice factoring or accounts receivables factoring is one of the oldest alternatives for continuing cash flow. Factors, third parties to the transaction between the seller and the buyer, purchase invoices and accounts receivables at a discount. This process allows companies to easily cover production purchases, payroll and other operational expenses without any interruption in their business.

Elements of factoring can be traced back to the Mesopotamians, who are credited with being the cradle of civilization and the first to generate business code structures and government regulations for commerce. Experts have evidence that proves 4,000 years ago, the Mesopotamians also created the concept of factoring. Following Mesopotamia, there is evidence that the Romans sold promissory notes at discounted prices. Roman merchants also enlisted the services of collectors to settle trade debts. But factoring as we know it today got its start in the Middle Ages.

Jews, fleeing persecution in Spain in the 1300s and1400s, fled to Italy. In Italy, Jews were not allowed to hold land, but were still given the opportunity to engage in the local commerce in grain crops. Jews, who were not bound by the local Christian laws of usury, charging a fee to use money, gave high-risk loans to farmers against the crops in their fields. Originally, they purchased the grain sale rights against the coming harvest. As in any venture, where there is profitability, there is expansion. These early merchant bankers began to advance money against the delivery and payment of grain shipped abroad and to distant trading ports. Soon, the profitability of this endeavor opened the floodgates to a new segment of society and created a new industry within the trade industry of merchants who solely bought and traded grain debt instead of the actually grain itself.

By the time English colonists settled in the new world, America, this type of financing had become common. Both English settlers in the new world and English merchants were in prime situations to make lots of money. Due to the time distance in getting their goods, by boat, from the colonies back to England and vice versa, these merchants could have gone bankrupt waiting on their money. Cotton, timber, fur and tobacco industries all spurned their own factoring segments. Merchant bankers in London advanced funds to colonists for goods and materials before they made the journey across the ocean. They would ship their goods to the colonists or back to England where one of these factors would pay a discounted rate to the seller before the voyage and afterwards take a percentage for selling and collecting the money owed.

Factoring became a common business practice. Until the 1700s, England and the US shared a common law framework. Originally, English law forbade the selling of invoices unless the debtor was notified in advance. Of course, the United States developed its own government. In the late 1940s United States almost wholly adopted non-notification factoring arrangements and witnessed a boom in factoring in textile industries and transportation industries.

Another type of factoring exploded on the seen with the introduction of credit cards. A credit card is a form of factoring where the credit card company advances the retailer and the service provider the cash before the individual actually pays for the invoice. The retailer and service provider are charged a small fee, but they are spared the hassles of financing the individual on their own and having to wait for that person to pay for their service or product.

Today, the purpose of invoice factoring has not changed. Factoring allows the business owner to operate his day-to-day business without the consequences of cash flow interruption. Factors purchase commercial accounts receivables or invoices from a business at a discount giving the company the opportunity to use and invest that cash right away,



Thanks to Thomas McCarthy for contributing this article to our Factoring blog:

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