Let’s say Blue Heron Co. has incurred an unforeseen expense — a big property tax bill, for example. Blue Heron does brisk business and can reasonably expect to collect a significant amount of revenue in the months to come. In the next quarter, the company will have more than enough cash to handle the tax bill.
Unfortunately, that tax bill can’t wait until the next quarter; it’s due much sooner. Blue Heron contacts a factoring company that may be able to provide funding. To start the process, Blue Heron sends the factor relevant information — this may include:
- a list of customers
- the company’s gross sales in the previous year
- the total amount of its outstanding invoices
- financing methods already utilized
After analyzing these elements, the factor determines that there is an acceptable level of risk involved in signing a transaction agreement with Blue Heron.
The factor then purchases $500,000 worth of outstanding invoices from its Blue Heron. At this stage, Blue Heron receives the 80% of the invoices’ value at the outset, as agreed by Blue Heron and the factor. This means that Blue Heron gets $400,000, which it uses to resolve its tax debt. Incidentally, this whole process has taken place over a brief time-span. After verifying the invoices, the factor sent this amount to Blue Heron 48 hours later.
At this point, the factor assumes the responsibility of collecting the accounts receivables that it purchased from Blue Heron. Once this has been accomplished, the factor sends the remaining $100,000 to Blue Heron — minus the factor’s transaction fee.