The short answer: accounts receivable factoring is a form of business funding. It allows companies to finance their accounts receivable from slow-paying customers.
Other common names for this product are factoring and invoice factoring.
Do you provide net-30 terms to clients?
Most commercial sales of products and services happen on credit terms. This arrangement gives clients 30 to 60 days to pay their invoices.
Actually, large clients often demand credit terms as a condition of doing business with them. It’s a good deal for them. They get to use your product/service for a month or two before paying.
It may be a good deal for your clients, but it is not a good deal for you. Many small and midsize companies cannot afford to hold on to an invoice for eight weeks. They need the funds sooner. They have to pay employees, suppliers, and other costs.
A common way to handle this situation is to offer clients a discount in exchange for an early payment. This strategy can work at times, but it is not always reliable. It still leaves your cash flow at the mercy of your clients.
Therein lies the problem. Small businesses need reliable cash flow.
The Solution: Accounts receivable factoring
You can get reliable cash flow by using accounts receivable factoring. This solution finances your accounts receivable and provides you with immediate funds. This funding enables you to pay employees, suppliers, and other expenses.
Additionally, receivables factoring helps you minimize bad debt. As part of their funding process, factoring companies review your clients’ credit profiles. This review enables you to make informed credit decisions about your clients and the terms you offer.
How does receivable factoring work?
Accounts receivable factoring transactions are structured as the purchase of the receivable. Most transactions are funded in two installments: the advance and the rebate. Transactions follow this structure:
- You deliver your products/services to your client.
- You send an invoice to your client.
- Factor advances up to 85% (this varies) of the receivable.
- Your client pays after 30 to 60 days.
- Factor rebates the remaining 15%, less the fee.
The advance rates vary based on the industry risk. Most industries get an advance of 80% to 85%.
Transportation companies and staffing companies can get higher advances – usually as high as 90% to 95%. Construction companies, due to their risk, often get advances of 70%.
To learn more about how transactions are structured, read “How do Factoring Companies Buy Accounts Receivable?”
Advance rates vary by industry
When looking for factoring, most clients focus on getting the lowest possible rate. Actually, it’s the combination of rate and advance that determines your total cost of funds. Total cost of funds is the best metric to compare factoring proposals.
Advances are determined by your industry and transaction risk level. Here are some industry figures:
- General: 70% to 85%
- Staffing: 90% to 92%
- Medical: 60% to 80%
- Trucking: 90% to 95%
- Construction: 70% to 75%
How much does it cost?
The factoring rate is determined by the creditworthiness of your invoices, your factored volume, and transaction risk. Average rates range from 1.15% to 4.5% per 30 days. Rates can be prorated as needed to work with shorter periods of time.
Do you qualify?
Qualifying for receivables factoring is easier than qualifying for other types of financing.
The transaction is based on the creditworthiness of your clients. It is important that you work only with customers who have a good payment track record. Also, you should:
- Have unencumbered A/R (free of liens)
- Be free of legal or tax problems
- Have experience in your industry
Accounts receivable factoring has many benefits over other solutions. Benefits include:
- Lines can grow with your business
- It is easier to get than other solutions
- It does not require that you give up equity
- It can be used as a short-term solution
Recourse vs. non-recourse transactions
Most factoring companies factor receivables using a “recourse” model. With this model, your company is responsible for any unpaid invoices.
Some factoring companies offer a “non-recourse” factoring program. In this model, your company is not responsible for any client non-payments if two conditions are met.
First, the reason for non-payment must be a declared bankruptcy of your client. Second, the bankruptcy must happen during the 90-day invoice purchase period. Note that “non-recourse” factoring plans vary by company.
Which model is better? This question is common. The methods are similar. As a rule, finance companies buy only creditworthy invoices regardless of recourse. This strategy protects them by ensuring the chances of default are slim.
However, non-recourse companies may charge slightly higher fees and have more restrictive clauses. This approach lowers their risk.
Learn more about recourse vs non-recourse factoring.
The application process is simple
The application process is simple and usually takes a few days. To get started, most factoring companies request this information:
- An application
- Articles of incorporation or LLC operating agreement
- Recent receivables aging report
Note that complex situations, or applications for large amounts, require additional information. If you are considering a factoring solution, read these application tips.
How to select the right finance company
Many companies provide accounts receivable factoring. It’s a competitive market. However, not all factoring companies are the same. It is important to select the right company for your business.
Here are some simple questions to help you determine if a company is right for you.
1. What industries do they work in?
Most factors claim to be generalists that can work in any industry. However, most factors specialize in a few industries. You will be better served by a finance company that has experience in your industry.
2. Are their advances and rates competitive?
Determine if their rates and advances are competitive by comparing factoring proposals.
Proposals’ terms can differ significantly, making simple comparisons difficult. This article shows how to compare factoring proposals.
3. Do they have minimums?
A “minimum” is the least amount of receivables that you must factor each month. Some companies offer plans with no minimums, while others have minimums.
Usually, factors are willing to provide a price discount to clients who agree to a minimum volume. You can use this strategically to your advantage, but be cautious.
4. Do they offer good service?
Service is an extremely important component of a factoring plan. Good service is key to success. Every factoring company claims to “have great service”. However, don’t take their word for it.
Ask them for client references – and call the references. By the way, we usually give your prospective clients the options to speak with a client early on. Learn more at “Why work with us?”
5. How long have they been in business?
Lastly, there are a number of new factoring companies in the marketplace. However, you are usually better off with an established company that has years of experience.
Looking for accounts receivable factoring?
We are a leading provider of accounts receivable factoring. For a quote, click here or call (877) 300 3258.