To generate cash flow in an industry with long invoice periods, manufacturers and retailers of garments and accessories often rely on factoring as a financing source. Factoring is a transaction in which a company sells its accounts receivables owed by third-party customers to a funding source (a factor) for a cash advance against the purchased accounts. (Fashion Law: Overview, Practical Law Practice Note 2-616-4923). Factoring may occur on a one-time or revolving basis.
The Factoring Process
The factoring process begins with a financial institution or private finance company purchasing a brand’s accounts receivable (the money due to a brand as a result of its providing of goods and/or services). The factor advances some portion of the value of the receivables to the brand up front, using the receivables as collateral. The factor then collects the payment directly from the brand’s customer (commonly a retailer) usually 30, 60 or 90 days thereafter. Once the receivables are collected, the factor pays the brand the amount it initially held back, minus the fees it charges for its services.
As for the fee structures utilized by factors, most companies tend to keep fee structure information confidential, holding that the business is “too competitive to disclose this information.” (BFM http://businessfinancemag.com/tax-amp-accounting/factoring-comes-fashion). However, “the overall cost generally includes a rate charged on the value of the advance. According to several factors, the percentage rate on invoices can range from 2 to 6 percent every 30 days; invoices that the factor feels are riskier generally carry a higher fee.” (BFM http://businessfinancemag.com/tax-amp-accounting/factoring-comes-fashion).
If the retailer cannot pay, the factor usually must pay the full invoiced amount to the brand, although the factoring transaction can be structured with or without recourse. Therefore, factors are more concerned about the retailer’s creditworthiness than the brand’s.
Types of Factoring Arrangements
Brands can typically choose between two types of factoring arrangements. In a non-recourse arrangement, “the factor assumes all risk of nonpayment. If the customer doesn't pay, the factor has no legal claim against its customer.”
With a recourse factoring arrangement, “once a receivable has been outstanding for a certain period of time, such as 90 days, and is deemed uncollectible, the factor can reduce the reserve payment by the amount of the uncollectible invoice.” (BFM http://businessfinancemag.com/tax-amp-accounting/factoring-comes-fashion).
Factoring vs. Financing
Factoring differs from traditional financing. “It is not to be confused with financing, you may need to produce the goods. Factoring is not production related lending. You’d need to come up with the money to buy fabrics and pay your contractors ahead of time.” (FI http://fashion-incubator.com/factoring_invoices_financing_a_fashion_line/).
Additionally, “factoring varies significantly from traditional bank loans; each weighs different factors of a business’s financial health. Factors weigh a company’s balance sheet in strikingly different ways. One dramatic example is inventory. Traditional banking perceives inventory as an asset while I consider inventory to be a liability -as does any lean manufacturing proponent.” (FI http://fashion-incubator.com/factoring_invoices_financing_a_fashion_line/).