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Home » Financing & Credit

Step-by-Step Guide to Accounts Receivable Factoring

It’s a challenge every B2B business owner has faced at one point or another: those customers who pay invoices at a snail’s pace, causing your business financial hiccups of all types and sizes.

At best these delays are simply aggravating or force you to move a little extra money around. In the worst case, though, serious cash flow disruptions can translate into missed payments to your own vendors, jeopardizing your business relationships and even the credit score you’ve worked so hard for.

Luckily, there are business financing options—like accounts receivable factoring—that can help smooth out your cash flow while your customers catch up. Accounts receivable factoring—also called invoice factoring—can be a great solution for small business owners who have incoming revenue on their balance sheets, but who need to bridge the gap to getting timely payments.

How It Works

Essentially, accounts receivable factoring means you’re selling your outstanding invoices. Anaccounts receivable factoring company will buy your receivables by advancing you 50 to 90 percent of the amount of your total invoice, with the remaining 10 to 50 percent held in reserve. When your customer pays in full, the company will pay you back the amount of the reserve, minus their fees.

Typically lenders will charge a 3% processing fee on the invoice amount, plus a 1% “factor fee” for each week the invoice remains outstanding. Some factoring companies will even assume your debt and manage collections on your behalf for an additional fee.

Accounts receivable factoring is a great option for the small business owner or occasional slow paying customers who need a cash injection to cover operational expenses.

Determining Your Eligibility and Rates

When a factoring company considers how much to advance or loan your company, it takes several things into account. In most cases, the larger the invoice amount, the more value it represents and the better the deal you’ll be able to make. Since older invoices are harder to collect on, they are also less likely to qualify for accounts receivables factoring, or may come with a higher factor rate. Because of this, you’re best off reaching out to the factoring company as soon as possible after the account becomes delinquent.

Business owners can expect around 85% of their invoice value from factoring companies, with 15% of the invoice to be held in reserve.

Upsides

Accounts receivable factoring offers your business fast access to cash, even when customers are slow to pay. Although every situation is different, you can often get funds for outstanding invoices in as little as one business day.

Since your invoices themselves serve as the collateral on the loan, no extra collateral is required for accounts receivables factoring. And unlike traditional small business loans, lenders typically don’t require a pile of documentation and information about your business before you can be approved; they simply want to know that taking on your accounts receivables is smart business, so they are only concerned with your outstanding invoices. That makes accounts receivables factoring an attractive option if you have poor credit or have struggled to qualify for other small business loan types.

While not every factoring company will do this, some will take on your debt and collect accounts receivables for you. This can be a major advantage if you are in a busy season or if you don’t have the in-house resources to manage collections.

Downsides

Although accounts receivable factoring has lots of upsides, there are also some disadvantages to consider. When compared with other more traditional small business loan options, accounts receivable factoring is one of the more expensive ways to finance your business. Fast cash is often expensive cash, and this option is no exception.

Also, although accounts receivable factoring is uncomplicated, it does require you to relinquish some of your hard-earned profits, since you won’t receive the full amount your customer owes you. For example, if your client’s outstanding invoice is $10,000, you’d be giving up at least $400 in order to collect. Even so, if you’re willing to part with that to access the other $9,600, then accounts receivable factoring may be the right choice for you.

When Accounts Receivable Factoring Is the Best Choice for You

Customers who pay invoices at a leisurely pace impact your cost of doing business. Before doing business with a factoring company, you’ll want to make sure that the cost is worth it to you and your bottom line.

Like any small business loan, there isn’t one formula that will guarantee which loan is best for your business. That said, some businesses may benefit more than others in using accounts receivable factoring.

Accounts receivable factoring may be the right choice if your company:

  • Has current, outstanding invoices.
  • Is a B2B model.
  • Offers payment windows between 30 and 120 days.
  • Sells products or services on a “final sale” basis; factoring companies do not work with businesses that sell products on a contingent basis.

While any company with a B2B model can utilize accounts receivable factoring, if you are a trucking, manufacturing, distribution, staffing, or a commercial landscaping company, you may find this loan structure aligns well with your business needs.

Accounts receivable factoring can be a good way to bridge the cash flow gap with slow-paying customers. As always, best practice is to ensure that this financing solution will not only ease your short-term cash flow crunch, but also make long-term financials sense for your business.

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