Accounts receivable factoring is a type of business financing that helps companies with cash flow issues. It allows companies to finance their accounts receivable (A/R), which provides immediate funding. A/R factoring is commonly used by small and growing companies that don’t have large cash reserves. In this article, we cover:
- Do you provide net-30 terms to clients?
- What is accounts receivable factoring?
- How does factoring work?
- How much does it cost?
- Does my company qualify?
- How to evaluate factoring companies
1. Do you provide net-30 terms to clients?
Most commercial sales of products and services happen on credit terms. This arrangement gives your clients 30 to 60 days to pay their invoices.
Large clients often demand credit terms as a condition of doing business with them. Getting terms is advantageous for your clients because it helps them with their cash flow. The client gets to use your product/service for a month or two before paying.
However, offering terms is difficult and can create financial problems for companies with small cash reserves. Many small and midsize companies can’t afford to wait eight weeks to have an invoice paid. They need the funds sooner to pay employees, suppliers, and other costs.
A simple solution is to offer early payment discounts to select customers. As its name implies, this solution gives the client a 1% to 2% discount if they pay within ten days. Otherwise, the client must pay the total cost of the invoice on their usual terms. Offering these discounts can improve your cash flow if problems are mild.
Early payment discounts have drawbacks and aren’t always reliable, especially during difficult times. In most cases, companies can get reliable cash flow by factoring their accounts receivable.
2. What is accounts receivable factoring?
Accounts receivable factoring is a financing solution that enables you to leverage your A/R and convert it to cash. It’s designed to provide immediate working capital, enabling business owners to pay expenses and grow.
Factoring helps small and growing businesses that can’t qualify for conventional financing. The approval process relies mainly on the credit quality of your invoices rather than on the financial strength of your company. Small companies with a solid roster of clients can usually qualify.
3. How does receivable factoring work?
Receivables factoring transactions are usually structured as a sale of your invoices rather than a loan. Your company sells its invoices to the factoring company. In exchange, the factoring company pays you shortly after the purchase. This process can be repeated as often as needed.
Most transactions are funded in two installments: the advance and the rebate. Transactions follow this timeline:
- You deliver your products/services to your client.
- You send an invoice to your client.
- The factor advances up to 85% (this amount varies) of the receivable.
- Your client pays after 30 to 60 days.
- The 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%.
a) Recourse vs. non-recourse transactions
Receivables factoring is offered in two different ways: with full recourse and non-recourse. This distinction is often a source of confusion for potential clients.
In a full recourse transaction, the client is responsible for paying the factor if the end customer does not pay the invoice within a set time period. This option is the most common type of factoring in the industry.
In a non-recourse transaction, the client has to repay the factor only if the invoice is not paid due to an end customer’s formal bankruptcy. Note that the client is always responsible for the invoice if the end customer does not pay due to an invoice dispute.
Contrary to common belief, non-recourse factoring is not inherently better than full-recourse factoring. Most factoring companies have credit monitoring systems that prevent them from buying risky receivables. This monitoring limits the chances they will finance a risky invoice. Additionally, non-recourse protection is usually applicable only if the end customer declares bankruptcy during the 90-day factoring period. Lastly, some factoring companies compensate for their non-recourse risk by offering lower advances at a higher cost.
Non-recourse factoring can offer good protection against unexpected bankruptcies. While uncommon, these events can significantly impact clients who have only a few customers. For more information, read “Recourse vs Non-Recourse Factoring.”
b) Advance rates vary by industry
Your industry and transaction risk level determine the size of factoring advances. Here are some industry figures:
- General: 70% to 85%
- Trucking: 90% to 95%
- Staffing: 90% to 92%
- Medical: 60% to 80%
- Construction: 70% to 75%
4. 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 a shorter time period. Keep in mind that there is a difference between “factoring rate” and “factoring cost.” To learn more, read “How Much Does Factoring Cost?”
5. 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
- It is available to small business
- It can be set up quickly
7. How to select the right finance company
The factoring industry is competitive, and there are a number of providers. However, not all factoring companies are the same. Many specialize in specific industries and have their own strengths and weaknesses. It is important to select the right company for your business.
Here is a list of important questions to help you determine if a company is right for you.
a) What industries do they work in?
Most factors claim to be generalists that can work in any industry. In reality, most factors specialize in a few industries. You will be better served by a finance company with experience in your industry.
b). 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. To learn more, read “How to Compare Factoring Proposals.”
c) Do they have minimums?
A “minimum” is the least amount of receivables that you must factor every 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 minimums strategically to your advantage, but be cautious.
d) Do they offer good service?
Service is an extremely important component of a factoring plan. Good service is key to your 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 option to speak with a client early on. Learn more at “Why Work with Us?”
e) 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 with 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.