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Questions Before Getting Accounts Receivable Factoring – Q & A

Business owner with a coffee and a laptop review receivables factoring terms

If you’re a small business owner, you may have heard of accounts receivable factoring. This type of business financing allows you to borrow against your outstanding invoices, giving you the cash you need to keep your business running. But what are the facts about this type of financing? Here are some frequently asked questions that will help you understand how it works.

What do you mean by factoring receivables?

Accounts Receivable Factoring is sometimes called “Invoice Factoring.” It refers to the process of when a business sells unpaid invoices to an accounts receivable factoring company or a “Factor” for a discount rate. It is now the job of the factoring company to collect the payment from your customer. Once the factoring company collects from the client, they pay the small business owner the remainder of the invoice amount, minus factoring fees.

What are typical factoring fees?

Factoring costs can be calculated in many different ways, depending on your needs. One way is to multiply the value of an invoice by a flat rate and then pay that amount every month for 30 or more days until it’s paid off completely. The range varies from 1% up to 5% per month.

Why do companies factor invoices?

Companies can sell their accounts receivable to a third party for less than they are worth to increase cash flow. The factoring company will review the invoices (and the invoiced customers) to gauge their repayment risk. Once approved, the receivables are sold, and the factoring company will fund your business within days. 

How does a factoring account work?

So when you sell your accounts receivables to a third-party factoring company, the discounted purchase price gets calculated using what’s known as a factor rate. Here’s an example.

Let’s say you sold $20,000 of outstanding receivables. And let’s say the factor rate is 3%. The purchase price of your receivables would then be $20,000 less minus the factor rate. So you’d receive 97% of $20,000. This means the factor would buy your receivables for $19,400.

However, this does not mean you would receive $19,400 immediately. Instead, you’re more likely to receive an upfront advance. For our example, let’s use 85% of the purchase price. So you would receive $16,490 now.

And then, once the factor collects on your receivables, you’d receive the remaining 15% (that works out to $2,910) of the purchase price of your receivables.

Will a factoring company accept all of your company’s receivables?

Factoring companies will only accept payment for the receivables they have purchased from a merchant.

What are the disadvantages of debt factoring?

Factoring is a great way to get your customers’ invoices paid quickly and easily, but there are some disadvantages. For instance, due diligence is always required before any business deals with this type of finance because it can be risky if not done correctly. Most providers also verify invoices carefully and ask questions about how you run your company. Factoring is also expected to be a quick process that should take no longer than 30-60 days. If your client doesn’t repay the invoice quickly, the factor’s increased charges could make the financing very expensive. 

How does debt factoring work?

Debt factoring can be a way to fund your business by using the most significant asset you have – accounts receivable. Account representatives collect full invoice payments from clients and pay them directly, minus any fees they charge. 

What are the disadvantages of using a factoring company?

Factoring is an excellent option for companies that need quick access to funds. However, it does come with some disadvantages, such as cost and unfavorable treatment of bad debt by finance companies.  

What companies use factoring?

Some of the most popular companies that use factoring are trucking firms, freight brokers, and business service providers. 

Why do companies use factoring?

Factoring can be an excellent way for companies with slow-paying clients to get back on track. The process of factoring an account receivable without delay provides the cash they need, eliminating any cash flow problems and granting them some much-needed liquidity that allows you to meet payroll and cover other expenses like mortgages or rent payments.

Why would you buy accounts receivable?

Accounts receivable are the most important financial asset for any business. Selling them at a discount can help solve immediate cash flow problems.

Who buys accounts receivable?

Factoring companies will review your invoices based on the amount of funding you’re looking for and then decided whether or not to purchase the receivables at a discount. 

Are factoring companies worth it?

Factoring companies are worth it if you need cash quickly. They can provide efficient solutions for overcoming shortfalls, and factored invoices don’t require additional payment beyond the original invoice amount, unlike other methods.  

What happens when you sell receivables?

When a business sells receivables, it’s trading future income for immediate liquidity. The factoring company will buy an invoice from the customer and pay them upfront.

Can you sell your receivables?

The short answer is YES. Companies usually sell their receivables to free up cash flow to cover costs or make investments that could increase sales/profits.

Is factoring invoices a good idea?

Waiting to get paid is frustrating, but factoring in invoices can be a good option. Invoice loan payments are often more accessible than waiting on customers and give you the money needed for your business. 

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