Guide to Factoring of Account Receivables

Late-paying customers can present cash flow problems for cash-strapped businesses that need prompt invoice payments to stay afloat. For such businesses, loans don't make much sense because they take a long time to get approved and only add to the business's overhead.

The next best option is invoice factoring, which allows businesses to get invoices paid sooner and not have to chase down the customers offering discounts as a way of them paying ahead of time. Additionally, factoring allows them to save up on resources and better allocate them to the growth of the business.

Without exploring account receivables factoring, you could miss opportunities to grow and invest in your business's future.

What is Account Receivables Factoring?

Factoring is not a new or unproven concept. It has been around for some time but is [still] considered a modern method of financing. With accounts receivables factoring, the company sells unpaid invoices or accounts receivables to a third-party financial company known as the factor at a discount for immediate cash. When you factor in your accounts receivables, your company gets immediate payment for outstanding invoices to improve cash flow.

This saves the business from having to wait for the duration agreed on the invoice payment terms. Invoice factoring is not a loan or line of credit but involves the sale of receivables to a factor. It is also not a debt, does not affect equity, and does not depend solely on the client's credit but rather on the credit of the client's customers.

How Does Accounts Receivables Factoring Work?

The process of accounts receivables factoring follows several steps. The details of the process can change depending on the type of factoring you settle for, but the general steps are as follows:

  • Your business submits an invoice to the factoring company
  • The factoring company advances percentages, usually 80% to the seller
  • The factoring company holds the remaining percentage of the advance as security.
  • The factoring company receives the payment from the customer
  • The factoring company clears the remaining payment amount and completes the final payment to the seller, less their fees and other charges.

Once you submit the invoices, the factor will verify the details and ensure the invoices qualify. In most transactions, the factoring company advances up to 80% of the factored amount within a few hours of the invoice submission.

The factoring company then holds the remaining amount until the day the invoice is cleared. The fees are calculated as a discount percentage of the invoice value and can also include other interests.

Benefits of Account Receivables Factoring

Account receivables factoring can be beneficial to businesses on many levels. It's an unconventional financing method that allows the business to free up cash tied up in unpaid invoices without taking on more debt. Some of the benefits associated with account receivables factoring include:

  • It is a very simple form of commercial financing, and the main requirement is usually a client base with good credit.
  • Your credit history is not usually considered. So, if you have an adverse credit history or have been operating for some time, you can also benefit from your clients' good credit history.
  • After selling your invoice, the factor may be the ones that chase the payment. That means you may no longer have to worry about playing the role of the collector, and you can channel that energy to develop your business. The money will eventually come back to your business minus their fee. [NB: facilities can be full collection services / partnerships or primarily remain with you. Subject to facility guidelines].
  • Account receivable factoring helps businesses obtain immediate cash flow and capital for growth without taking on more debt through loans.

Disadvantages of Account Receivable Factoring

The greatest disadvantage of account receivable factoring is that there is a fee for using the service. The factoring company buys the invoice at discounted prices, meaning you will receive less money than you processed in your invoices.

Why You Should Consider Accounts Receivable Factoring

Improve customer service

Account receivable factoring can help companies provide better customer service by offering more flexible payment terms and reducing the time and effort required to collect customer payments.

With immediate access to cash, you can offer more flexible options to your customers by honouring or extending payment terms that enhance customer experience.

[If offered] outsourcing accounts receivable collections to a factoring company can reduce the time and resources and cost spent chasing customers for overdue payments and instead use those efforts to grow the business.

Easier application process

Another reason businesses should consider accounts receivable factoring is that it is easier to access than bank loans. The process doesn't require collateral or impact a business's credit rating. Accounts receivable factoring enables companies to control their finances and grow and contract in sync with the fluctuations of the business trading cycle[s].

Fast cash flow

Using this invoice financing method, you can free up revenue tied up in unpaid invoices. It makes it easier for the business to meet its obligations, which include overhead costs and payroll. Processing with factoring companies is usually fast, giving the business immediate access to cash flow without waiting for customers to pay invoices in full.

Additionally, accounts receivable factoring doesn't impact a business's credit rating or loan interest rate. Still, it can be a great way for the business to mend its credit rating by paying its suppliers on or ahead of time.

Reasons to Use Accounts Receivable Factoring

Accounts receivables can be useful when the business needs to improve its cash flow. Some great examples where factoring can be crucial include:

Maintaining off-season cash flow

Seasonal businesses with fluctuations in cash flow, such as holiday-related manufacturers or wholesale manufacturers, may need additional cash to cover operating expenses in the offseason. Accounts receivable factoring can be a reliable funding source to bridge the gap between slow and busy times of the year.

Facilitate business growth

Businesses looking to expand, move to a new location or launch a new product may require additional funding. Factoring accounts receivables helps them obtain the funding they need and eliminate cash flow concerns simultaneously.

Improve risk management

Invoice factoring can be great for risk management and can help avoid non-payment. By purchasing accounts receivables from businesses with strong credit ratings and reliable customers, finance companies can reduce exposure to bad debts.

What is the Cost of Accounts Receivable Factoring?

The cost of accounts receivable factoring depends on the factoring company and its terms. However, if you choose to factor with us, our fees are transparent upfront and have no hidden fees. We provide you with a full quote for the service, making it easier to know how much the service will cost before committing to it.

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