Companies that work with commercial clients often have to wait 30 to 60 days before getting paid. This practice is known as offering “net terms” and is common in commercial and government sales, where clients often demand terms as a condition of awarding a contract.
Offering terms creates a dilemma for companies that don’t have the cash reserves to wait for payment. They need to get paid sooner so that they can pay for their expenses. If they take on the new client, they risk financial problems.
The solution is to use accounts receivable financing. It helps companies improve their cash flow by allowing them to finance their slow-paying invoices. This strategy enables the company to take on more clients and grow. Note that the terms “accounts receivable financing,” “factoring,” “invoice factoring,” and “receivables financing” are often used interchangeably.
The accounts receivable financing process
We have divided the setup and funding process into six steps. In most cases, setting up your company for initial funding takes a couple of days. After that, receivables can be financed regularly, usually within a business day of submitting them to the factor. This article assumes you are familiar with accounts receivable factoring. If you are not, consider reading “What is accounts receivable factoring?” first.
Step #1: Due diligence and account setup
Once you accept a finance proposal, the factoring company starts its due diligence process. Due diligence allows the finance company to determine if your business can be financed. The factor usually checks some basic items:
- The credit quality of your clients
- Your receivables aging report
- If any liens encumber your receivables
- If your corporate taxes are up to date
- The relevant background of the business owners
Keep in mind that a larger funding facility may need more detailed diligence. Once the due diligence is completed, contracts are issued. The account is activated when the contracts are signed.
Step #2: Selecting the customers you will finance
The next step is to select the customers that you want to finance. These clients are sent a Notice of Assignment (NOA), a standard procedure in the factoring industry. Your customers receive an NOA only once – when you start financing their invoices.
Step #3: Submit invoices and prepare for funding
At this point, you are ready to submit invoices for funding. Invoices can be submitted via email or through a web portal – the process varies by factoring company. Invoices are usually submitted along with a schedule of accounts document. The schedule of accounts serves as the formal request for funding. Once received, the invoices are also verified to ensure they are accurate, free of offsets, and due in 30 to 60 days.
Step #4: Funding the invoices
After verification, the invoices are ready for funding. The finance company calculates the advance and deposits the funds in the client’s bank account. The advance is the percentage of the invoice that is funded. It varies by industry and other criteria but averages 80%. In general, advances are provided within a business day of getting the funds request.
Funds can be advanced to the client by wire transfer or by direct deposit (ACH). Wire transfers provide funds availability the next business day. Direct deposits can take a day or two, depending on your bank.
Step #5: Invoice payments and account settlement
Your customers pay invoices on their regular schedule. Mailed payments are sent to a bank lockbox. The bank’s lockbox is a facility that allows the factoring company to process check payments in your name. If your customer pays electronically, the funds are deposited to a special account.
Once the funds are received, the transactions are settled. Invoices are marked as paid, and the remaining 20% that was not initially advanced, less a financing fee, is rebated.
Step #6: Ongoing financing process
Most companies finance their receivables as part of an ongoing process to improve cash flow. It is as simple as repeating steps three through five. Factoring accounts receivable provides companies with funds to pay for expenses and to run the business.
Contract termination
One common question from clients is how to handle contract terminations. Basically, what happens when your factoring contract expires? There are a few ways to terminate contracts. Consult your finance company directly because the process varies. In general:
- If you are moving to a new lender (e.g., a bank), you use the proceeds from the new lender to close your factoring account.
- If you are no longer using financing, you let accounts pay out. The factor closes invoices as they pay and closes your account when the last invoice pays.
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