Funding Your Business With Accounts Receivable Financing
Accounts receivable financing, also known as factoring, has been used by companies for generations. When a business factors its receivables, it sells unpaid invoices to the financing company, also known as the factor. The factor typically gives the business a percentage of the invoice immediately while they wait for payment. When the invoice is due to be paid, the payor remits payment directly to the factor. Once payment is made, the company receives the balance of the invoice less the factoring fee.
Benefits of Factoring
For companies that experience cash flow challenges, factoring often smooths cash flow because cash is available sooner for more inventory purchases or to meet payroll before the invoice is actually paid by the customer. Factoring normally takes the burden of accounts receivable management and collections from the company’s accounting department staff, who can then redirect their efforts to other time-sensitive activities. Because factoring is not considered a loan that would typically be recorded on the balance sheet, this type of financing frequently does not impact loan to income ratios that may be required to qualify for other types of bank financing. Because collateral is normally not required, business or personal assets are not pledged should the invoices remain unpaid.
Considerations About Factoring
Business owners may want to consider certain issues prior to pursuing this financing source. Some businesses are not comfortable when their customers have direct communication with a factoring company and feel that their customers will perceive that the business is struggling when it factors receivables. It is important to select a factor who has a reputation for giving excellent customer service and who can help explain the benefits of factoring.
Accounts receivable financing companies may not accept invoices from all customers depending on their credit history or they pay a smaller percentage of the invoice or charge a higher fee when the customer has lower credit. Some factors require the company sells a minimum dollar amount of invoices per month or that the company to commit to factoring for a specific length of time. Other factors do not require minimum business levels. Factors frequently require the company to buy back unpaid invoices, while others take on the full risk of payment. The factoring cost will potentially vary depending on these types of contact terms.
Understanding Factoring Options
Accounts receivable financing has allowed many businesses to solve cash flow challenges. Understanding the pros and cons of factoring and the differences between factors can help a company identify the right factoring program to serve its business.