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Intro To Accounts Receivable Factoring
Many businesses do not get paid immediately after providing their goods or services. These businesses include everyone from medical practices to construction contractors to wholesalers. Instead, business owners must wait several weeks to receive payment. If the client takes longer than expected to pay on an outstanding invoice, that time frame can go from weeks to months. And even if the customer pays on time, the sale might become less profitable if compensation arrives just before monthly bills are due. Thankfully, you can avoid both dilemmas with Accounts Receivable Factoring.
This type of flexible financing shortens your payment cycle to just a few days, allowing you to alleviate your cash flow challenges, increase profitability, and cover sudden expenses.
In this guide, we’ll answer the following questions about accounts receivable factoring and more:
What Is Accounts Receivable Factoring?
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 from the invoice amount, minus factoring fees.
Invoice factoring loans are a solution meant for small business owners who experience a long lapse between when a service is rendered and when the invoice is paid. This type of financial transaction allows the business owner to receive payment on their accounts receivables sooner.
How Does Accounts Receivable Factoring Work?
Accounts receivable financing carries very different requirements than other business financing products. This is because factoring companies are more concerned with the creditworthiness of your customer, not you. Therefore, you do not need an excellent credit history or perfect cash flow to access this product. Accessibility is more dependent on your customer’s perceived ability to pay within a reasonable time frame. If the factoring company isn’t sure your customer will pay at all or believes it will be tough to collect the payment, you may not get approved.
These factors also determine the percentage of the invoice that the factoring company purchases along with your factoring fee. In most cases, the factoring company will purchase 85%-90% of the invoice. You would receive this money in just a few business days instead of several weeks or months.
Each factoring company has its fee policy for the second payment, which occurs when the factoring company collects from your customer. Generally, if the factor rate is lower, the fee for the second payment will be higher.
Yes, you lose a little bit of income. That’s the price you pay for receiving money right away and relinquishing the responsibility of collecting the payment.
An Example of Invoice Factoring
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.
Receivables Factoring – Research, Facts, and Reports
Recent research predicts the global invoice factoring market to reach $9.27 trillion by 2025. Source: Adroit Market Research
Accounts receivable financing is forecast to rise across the globe at a Compound Annual Growth Rate of 11.03 percent through 2020. Source: American Express: Factoring is Boosting Trade & Supply Chain Finance
Researchers forecast the international receivables factoring market to grow by 15.8% from 2018 to 2025. Source: Adroit Market Research: Global Factoring Market 2019 – 2025 Analysis
What Are The Advantages of Accounts Receivable Factoring?
Like other types of working capital loans, receivables factoring is available for companies with subpar credit history and rocky cash flow. As long as your client has paid its bills in the past, you probably won’t have trouble getting approved.
To understand this product’s most significant advantages, you must first consider the consequences of late-paying customers. The longer an invoice goes unpaid, the less profitable the sale becomes. It’s like unsold inventory sitting on your shelves. Your company is continuing to spend money while less money is flowing in. Even a two-week difference in the payment cycle can have a significant impact on profitability. If most of your clients pay at the end of the month, most of this money will likely go right into monthly bills. Profitability increases when you have more time to plug money back into your business before covering operational expenses.
In addition to money, factoring services save you the time of chasing down your clients. Once you sell the invoice, you can stop sending emails every day and possibly jeopardizing the partnership in the process.
On that note, there’s a common misconception that factoring companies will relentlessly bother your clients until they pay up. This couldn’t be further from the truth. If you work with a company like UCS, your client base won’t even find out you sold the invoice in the first place.
What Are The Disadvantages of Accounts Receivable Factoring?
Accounts Receivable Factoring is a form of near-term financing. Though it’s difficult to compare this product to traditional options like bank financing with a low interest rate, any short-term financing is not considered cheap. This is primarily due to the aforementioned loose requirements and fee system. For instance, merchant cash advances carry an advance rate, which is a factor rate as well and is therefore expensive by nature.
Also, you won’t get approved for accounts receivable financing if your customer appears unreliable. If a customer has already missed the due date by several weeks, collecting from this customer will probably be difficult. For this reason, accounts receivable factoring works best for established customers with many partners. Lesser-known small businesses don’t have the reputations or business credit profiles of their larger competitors.
Lastly, accounts receivable financing is far from the only solution to late-paying customers. Sometimes, simple tactics like sending more than one invoice per month are all you need to get customers to pay on time. Hence, you should only pursue accounts receivable factoring if you’ve explored other logical solutions for this cash flow issue.
- Get paid on your invoices and receivables in advance
- Invoices and receivables are treated as collateral
- Credit is based on business who is invoiced
- Use for a variety of business purposes
- Higher rates & fees than with traditional loans
- Fees are based on how long your customers take to pay your invoice
Accounts Receivable Loans Compared To Other Products
|LOAN TYPES||MAX AMOUNTS||RATES||SPEED|
|Merchant Cash Advance||$5k – $1m||Starting at 1.09||1-2 business days|
|SBA Loan||$50k-$10m||Starting at 3.75%||3-5 weeks|
|Business Term Loan||$10k to $5m||Starting at 5%||1-3 business days|
|Business Line of Credit||$1k to $450k||Starting at 1% p/mo||1-3 business days|
|Receivables/Invoice Factoring||$10k-$10m||Starting at 1% p/mo||1-2 weeks|
|Equipment Financing||Up to $5m per piece||Starting at 3.5%||3-10 business days|
|Revenue Based Business Loans||$10K – $5m||Starting at 1% p/mo||1-3 business days|
Who Qualifies For Receivables Factoring?
Approved businesses generally met the following criteria:
How To Apply For Accounts Receivable Factoring:
At UCS, we can work out arrangements with finance companies for as much as $10 million worth of receivables, with factor rates starting at 5.8%. The funding process usually takes up to two weeks. Here’s how to apply:
Step 1: Make Sure Your Customer is Reliable
An essential requirement for factoring companies in factoring invoices is the reliability of your customer. Before contacting a factoring company, you must be 100% certain that your customer will indeed pay their invoices within a reasonable time frame.
Step 2: Gather Your Documents
To apply, the finance company will need the following documents and information to see if factoring invoices is appropriate:
- Driver’s license
- Voided business check
- Bank statements from the past three months
- Business tax returns
- Account Receivable Aging report, Accounts Payable report, debt schedule
Step 3: Fill Out Application
You can begin the application process by giving us a call or filling out our one-page online application. Either way, you’ll be asked to enter the information from the previous section along with the value of the invoice amount you wish to sell.
Step 4: Speak to a Representative
Once you apply, a representative will reach out to you to explain the factoring fee, factor rate, and terms attached to the sale. This way, you won’t have to worry about any hidden fees during each payment.
Step 5: Receive Approval
The entire process takes about 2 weeks, and once the transaction is approved, funds should then appear in your bank account in 1-2 business days after completion.
Your Receivables Financing Gets Set Up – Now What?
Factoring your invoices isn’t just a deal to get financing for your business. It’s also an excellent opportunity to start building (or improving) your credit.
Regardless of the type of working capital financing you get, make all of your required payments on time and in full. If you get a business credit line or another form of revolving credit, keep your balance below the credit limit.
Consistently making your business financing payments on time and in full will positively impact your credit. And that means preferred rates and terms when you next need to enter into a factoring transaction.
What If I’m Declined For Accounts Receivable Factoring?
If factoring companies decline your application, it might be because the factors aren’t sure they’ll be able to collect from your customer. In this case, we might recommend another product to get the cash you need. This could include a business line of credit or various other products we offer that work best when covering more immediate needs.
If you have trouble qualifying for these options, we might recommend covering your expenses with a new business credit card or even a personal loan. Both options are much easier to qualify for than bank loans. If bad credit turns out to be your most significant obstacle to financing, you should consider these credit repair services. They can help you raise your score by focusing on eliminating the issues that are keeping it down.
People Also Ask:
Is Accounts Receivable Factoring a Loan?
Accounts receivable factoring is sometimes called an “accounts receivable loan.” This can be misleading because, technically speaking, accounts receivable financing is not categorized as a “loan.” It does not show up as “debt” on your balance sheet.
Similarly, a merchant cash advance is not categorized as “debt,” either. This is because both products involve a sale to the factoring company. With accounts receivable financing, you are selling invoices. With a merchant cash advance, you are selling a portion of your future debit and credit card sales.
Why Do Businesses Factor Their Invoices?
Larger businesses are notorious for being very slow to pay. They often pay after the due date and may even request terms of over 30 days. Smaller companies cannot afford to extend that kind of credit. However, larger companies also make more substantial orders, and maintaining the partnership can do wonders for your reputation.
With accounts receivable financing, smaller businesses can offer longer terms to entice larger customers. The tiny loss of income is a fair price for expanding their customer base to this level.
What’s the Difference Between Recourse & Non-Recourse Factoring?
Recourse factoring means that if a company sells its invoices to a factor and those invoices don’t get paid by your customers, that company would be forced to buy back those invoices. Essentially the company that sold the invoices to the factor would be responsible for non-payment of those invoices.
With Non-recourse factoring, the factor assumes the majority of the risk of non-payment of invoices. However, non-recourse factoring doesn’t absolve a company from all risk if the invoices aren’t paid. The terms for non-recourse factoring are particular. As an example, some factors offer non-recourse that applies if a debtor declares bankruptcy. Oftentimes, factors will only limit non-recourse options to only your clients that have a good credit history. Because of the high risk associated with non-recourse, factor rates tend to be higher.
Can Startup Companies Factor Their Invoices/Receivables?
When you’re a startup company, you might notice the cash balance in your checking account is getting low, and that money you tucked away in the reserve account is also tied up for future encumbrances. Instead of getting frustrated at your balance sheet, you can sell your invoices to a factor and get the cash you need asap. Because the finance company looks at your clients’ credit rather than yours, this is an easy way for startups to get the funding they need to beat cash flow gaps.
What Else Can Businesses Do To Get Paid On Time?
Since accounts receivable factoring comes with a cost, it should only be pursued if you’ve exhausted every other solution for getting paid on time. For example, you might not be making your invoices clear enough. The customer might delay the payment simply because they can’t figure out what they’re being charged for or when the payment is due.
Your invoice should display the following information:
- Invoice number
- Client’s name
- Your business name, address, contact info, and tax registration number (if required)
- Number of hours worked (for service calls)
- Hourly rate or unit price
- Any taxes charged
- Due Date
- Payment Terms
- Material descriptions and pay rates (if applicable)
Lastly, consider offering an incentive for paying on time. Many small businesses have found that this is the only way to get customers to follow their terms. You could offer a 2% discount for customers who pay in 30 days.
What If My Customer Takes Too Long to Pay?
Every factoring company has its own time frame for this scenario. However, most of them have the same penalization policy.
Accounts Receivable Factoring involves two payments. The first transaction occurs when the factoring company purchases the invoice, and the second occurs when the factoring company collects from your customer. If the factoring company cannot collect from your customer within the agreed-upon time frame, they will usually keep the second payment. So, before factoring your invoices, find out their payment deadline for keeping the second payment instead of giving it to you.
Will My Customer Find Out I Sold Their Invoice?
No, we will not tell your customer that you sold their invoice. We are also well aware that the way we collect the payment reflects upon you. Rest assured, the relationship you have with your customer will not be affected. The process of turning the invoices over to us is straightforward and stress-free for your customer. There’s a good chance you’ll find out that some of your customers are already sending payments to other factoring companies.
Is Accounts Receivable Factoring The Same As Invoice Financing?
These two terms sound alike but are very different. Like Accounts Receivable Factoring, Invoice Financing allows you to access financing based on your receivables’ value. But with the latter product, you aren’t selling your receivables to the finance company. Instead, the receivables merely act as collateral for a loan. And you are still responsible for collecting the payment from your customer.
Can I Get Accounts Receivable Factoring with Bad Credit?
Yes, accounts receivable factoring is available for borrowers with bad credit. It’s the creditworthiness of your customer, not you, that matters most with this product. Unlike a bank loan, your credit score literally has zero impact on the cost of accounts receivable factoring in most cases.