Many prospective factoring clients are surprised by the fact that invoices – or accounts receivable – can be sold to a finance company. This reaction is understandable, since an invoice is not a physical good, per se. It’s hard to imagine how a factor could buy it. This article explains how a factoring company purchases accounts receivable from a client.
What is the client selling?
When a client sells an invoice to a factor, they are actually selling the financial rights associated to that invoice. The sale of the receivable is made in exchange for an immediate payment.
As with any sale, the buyer (factor) and the client agree to contractual terms. Although there are many terms in a factoring contract, the two most common terms are “recourse” and “non-recourse.” The exact details are fairly complex, but the concept of recourse deals with what happens if your client does not pay the invoice when it’s due.
In a recourse transaction, the client must return the funds to the factor and make them whole if the customer does not pay an invoice. In a non-recourse transaction – and this varies by factoring company – the client does not have to return the funds if the factor is not paid due to an insolvency of your customer. Learn more about the different types of factoring.
Submitting an application
The first step in setting up an agreement to sell your receivables is to submit an application and all materials to the factoring company. Although each company has its own application process, most factors ask for the same set of documents. You can find more information about the application process by reading our factoring application tips. Once the application is received, the factoring company reviews it through a process called due diligence.
Due diligence involves the factor reviewing your application, determining if your accounts receivable can be purchased, and examining the creditworthiness of your customers. The process can take from one day to one week, depending on the complexity of your company.
If everything goes well and the application is approved, your company signs a formal agreement that allows the factor to purchase your receivables in exchange for an immediate payment.
Terms and rates
Terms and factoring rates vary based on the client’s industry, size, time in business, and perceived risk. The average advance rate is about 85%. However, they can go as high as 95% for some industries such as trucking and staffing. Rates can go from 1.15% to 5.5% per month – usually prorated in some way. Learn more about average factoring costs.
Notifications and invoice verifications
Two more steps must occur before the factor can make the purchase. First, they need to send a Notice of Assignment (NOA) to the customers whose receivables you want to finance. The NOA, a common document in the industry, advises your customers of the factoring relationship.
The second step is to verify your invoices. In this step, the factor verifies that your invoices are still open and due. Once this step is completed, the factor is ready to purchase the first batch of invoices.
Buying the first batch of receivables
The actual purchase of the accounts receivable is relatively simple. Usually it’s done online through a website or by email through a document called a “schedule of accounts.” The schedule of accounts lists the details of the invoices that you are selling to the factoring company.
Once this document is received and processed, the finance company sends you the funds either by direct deposit via ACH or by wire transfer.
Ongoing purchases of accounts receivable
From this point forward, your account can sell invoices to the factoring company regularly, based on your needs. All you need to do is submit the invoices, along with a schedule of accounts. Keep in mind that factors verify most invoices before purchasing, which minimizes the chances of funding mistakes. Learn more about factoring transactions.
Get a factoring quote
We are a leading accounts receivable factoring company and can provide you with high advances at low rates. For more information, call us at (877) 300 3258 or get an online factoring quote.