Oil factoring is the process by which oil companies sell their outstanding invoices to a third party at a discount. Most of the time, the third party will be a factoring company, and once they’ve done their due diligence, they then give the oil company the cash they were looking for. Oil factoring is mainly used as a means to raise quick cash required by companies to either pay staff, transport equipment or repair a drilling site (day-to-day expenses).
Difference Between Oil Factoring and Lending from A Bank
There lies a significant difference between oil factoring and getting a loan from a bank. While a bank loan is more reliable, and there’s a lesser chance of one being scammed, oil factoring has proven to be a really great alternative despite the risks that it carries. For starters, banks are under too many constraints and federal regulations that it is quite hard for them to finance oil companies.
Secondly, banks tend to focus on the company applying for the loan while factoring companies focus on the company’s clients. Therefore, if a company has bad credit, but its customers have higher credit ratings, they can still get the financing they need very easily, while the bank will be reluctant to provide the financing. However, this can work against them because if the oil company has good credit ratings, but its customers have lower credit, then they may miss out on the cash.
Also, it is worth pointing out that by going through the factoring process, oil companies reduce the chances of their credit score being affected since it will not be a loan and therefore not a liability. Factoring will simply change the accounts receivables to cash and thus keep the balance sheet ‘clean.’
Lastly, banks take a longer time to process loans, so in a way, it beats the point if the company needs quick cash. Factoring companies, on the other hand, take as little as three business days meaning that any company looking for quick cash can benefit.
How Oil Factoring Works
As mentioned earlier, oil factoring is basically the purchasing of an invoice from an oil company at a discount and offering them cash in exchange. For example, an oil company may complete a job for its customer, let’s say crude hauling. Now since this customer won’t pay on the spot and may take something in the region of thirty to sixty days, the oil company will create an invoice, and instead of sending it to the customer, they will send it to the factoring company. The factoring company will then do its due diligence and, after everything is completed, pay the crude hauler a certain percentage of the invoice, holding the rest until the customer pays. Once the customer pays, the rest of the sum is sent to the crude hauler, less the factoring fees.
Why Oil Companies Choose Oil Factoring
The main benefit of Oil factoring, and frankly the reason why most companies go for it, is because it offers a way to get quick cash without falling into debt.