What is spot factoring and how does it work? More importantly, why are more and more entities finding the need to use such method of financing? Let’s all find out.
First of all, what is it? Spot factoring falls under the category of receivables financing wherein a business entity makes use of a selected sales invoice from which to draw cash from. It is a sale transaction wherein the company sells its right to collect against it to a party called the factor in exchange for an advance of its value.
It is for the above reason as to why the method is an asset transaction thereby producing zero amount of debt. It doesn’t even have the effects and consequences of one. How is that possible?
In spot factoring, the business chooses a particular invoice. Oftentimes, it pertains to an account that has significant value and which can cater to the financial need of the entity. It is then sold to a factor who in turn gives about 80%-95% of its value. The remaining it shall retain and release only upon complete collection from the owing customer. The company shall then make use of the cash received whichever way it sees fit. Upon the invoice’s maturity, the factor shall then collect from the owing party and then release the remaining balance less fees to the company.
One very important reason as to why this method is preferred is because of its immediacy. Most if not all providers can arrange for the cash to be released in a matter of twenty four hours. This is not possible with other financing mediums. Furthermore, there are not as much frills and requirements to deal with making it less of a hassle.
Spot factoring also helps hasten collection and shift the burden. Apart from selling the rights to collection, the company also transfers the burdens thereof. If you remember, we mentioned that the collecting agent here is already the factor not the business. The entity shall no longer have to wait for the invoice’s maturity to receive the cash locked in them which spells good for liquidity, cash flow and working capital purposes.
Moreover, spot factoring can be used by everyone. Unlike bank loans and mortgages for example that are only available to established and heavily funded entities, the method is open to small to medium scale enterprises as well and even to startups and businesses in recovery. This is because the providers do not bank on the company’s creditworthiness but instead that of the customer’s.