If you are looking for ways to make sure that you are not dependent on invoices getting paid in order to have the kind of cash inflow that you should have, you might be interested in learning about receivable factoring.
Known either as receivable factoring or accounts receivable factoring, this is a popular form of business funding that works by allowing companies to finance their accounts receivable from slow-paying customers.
You may also know this form of funding through the term factoring or invoice factoring.
If you are curious about learning about the many benefits of invoice factoring, receivable factoring, or however you’d like to call it, then you have come to the right place.
What terms do you offer your clients?
As a business, you are probably much like many other commercial sale companies that offer their products or services on credit terms. In business, this typically means that clients get 30 to 60 days to pay their outstanding invoices.
In fact, large clients typically demand credit terms as a condition of doing business with them. The reason why is because it is a good deal for them as they get to use whatever product or service your business offers for a month or two without having to worry about paying you.
While this might be a great deal for your clients, it can be a pretty harmful deal for you and your business. Remember, many small and mid-size companies are not able to afford to hold onto an outstanding invoice for four to eight weeks. They need the money sooner so that they can pay their employees, fill out their stock, pay bills and general upkeep and much more.
One common way that companies handle this sometimes-uneasy situation is to offer clients a discount in exchange for expedited payment. This strategy can be a good way to get the money that you need, but not only is it not always totally reliable, but it also can leave a fair amount of cash that you deserve left on the table.
That’s what can make being a small business or midsize business owner so small. You depend on cash flow, but getting the cash flow that you need can be hard at times.
The best solution
While it may seem like you are often stuck between a rock and a hard place as a small business owner, receivable factoring is a great way to solve your need to get an influx in cash flow while not having to constantly hound your clients to complete their invoices.
This solution will finance your accounts receivables and provide you with immediate funds. This funding allows you to pay employees, suppliers and more.
Beyond that, receivable factoring can play a massive role in allowing you to reduce bad debt. As a part of their funding, factoring or receivable companies will review your clients’ credit profiles. This review makes it so that you can make informed credit decisions about your clients as well as the overall terms of your offer.
While it’s all good and dandy to learn that accounts receivable factoring is an option for you, that doesn’t mean you really know how it works yet. Luckily, we are going to break down precisely what it is together.
How does receivable factoring work?
Accounts receivable factoring transactions are going to be structured as the purchase of the receivable. Overall, the majority of these transactions are going to be funding in two separate installments. The first installment comes as an advance and the second installment comes as a rebate.
Transactions will follow the following structure:
- First, you deliver your products/services to your client(s)
- Then, you send an invoice to the client
- Next, factor advances between 75 percent and 95 percent of the receivable
- Then, your client will pay the invoice after 30 to 60 days
- Finally, factor rebates the remaining percentage subtracted by a fee
The advance rates vary based on the level of the industry risk. With that being said, the vast majority of industries will get somewhere between 80 percent and 85 percent.
However, transportation companies and staffing companies are known to get much higher advances. Usually as high as 90 percent to 95 percent.
One of the industries that tends to have lower advances are construction companies, which usually get around 70 percent.
Advance rates vary
When you are looking at factoring as an option, most clients tend to focus on working to get the lowest possible rate. However, it is actually the combination of the rate that you receive as well as the advance that you get that will determine the total cost of funding. The total costs of funding are the best metric to compare different offers that you get from various receivable deal proposals.
Overall, advances are going to be dictated by the industry that your company exists in as well as the risk level of the overall transaction. If you are curious what advance percentage your industry is known to get, here is a quick breakdown:
- General industry businesses will get 70 percent to 85 percent
- Staffing industry businesses will get 90 percent to 92 percent
- Medical industry businesses will get 60 percent to 80 percent
- Trucking industry businesses will get 90 percent to 95 percent
- Construction industry businesses will get 70 percent to 75 percent
How much will it cost you?
At this point, chances are good you are curious about how much accounts receivable factoring is going to cost you and your company if you decide to utilize it as a way to improve your cash flow. In the end, the factoring rate is going to be decided based on the creditworthiness of your invoices, your factored invoices as well as your transaction risk.
Overall, the average rates range between 1.15 percent on the low end and 4.50 percent on the high end per 30-day pay cycles. Rates can be prorated as well based on the need if you are looking for a shorter period of time.
How do I know if my business will qualify?
One of the primary benefits of this type of business financing is that qualifying for receivable factoring is actually easier than many other popular types of business funding. The reason why is because the transactions are based on the creditworthiness of your clients.
Because it is important to only work with clients who already have a good credit history so that you can depend on your invoices getting paid, you will likely not have a hard time having your clients’ credit scores meet the necessary criteria for gaining approval from factoring companies.
Beyond that, you should also make sure that you:
- Have unencumbered A/R, meaning your business is liens free
- Are free of legal or tax problems
- Have years of experience within your industry
By this point, you probably already have a pretty decent understanding of the many benefits that you could be afforded through receivable factoring. However, at this point we want all of the benefits to be abundantly clear for you. After all, that is probably the best way that you can be sure to know whether or not receivable factoring is right for you and your business.
- One of the top benefits is that the credit lines that you receive from receivable factoring companies can grow with your business. The reason why is because the amount that you may be eligible for will grow based on the number of invoices that you have left unpaid. Accounts receivable factoring amounts can range from a few thousand dollars to upwards of $20 million, so you can basically always be sure that you will be able to get the money that you need
- Another major benefit is that it is quite a bit easier to get funding through receivable factoring as opposed to other popular types of business financing such as taking out a business loan. The reason why is because your eligibility depends on the credit score of your clients, rather than your own credit score.
- Another major benefit to consider is that factoring will never force you to give up equity for your company or use your company as collateral. The reason why is because the ‘collateral’ in your deal are the invoices that you are already owed. With invoice factoring, you never have to worry about possibly losing your company if something unforeseeable takes place.
- Finally, a great benefit of receivable factoring is that the deals can either be long-term or short-term based on the specific needs of your business. If you are in need of a quick cash influx, you can do it for a month or two and continue on without it after that. If you are constantly struggling to access the kind of cash flow you need, you can depend on receivable factoring as a major aspect of your business. The choice is yours and factoring companies are willing and able to work with you.
Now that you know the basic aspects of receivable factoring, chances are good you have a great idea whether or not it is right for you. If it is, it’s time to start looking for some of the top companies in the industry to start taking advantage of this wonderful business funding option.