A Guide to Factoring Receivables
With accounts receivable factoring, you sell the outstanding invoices of your business. You sell them to a factoring company and they will take on the responsibility of taking the debt and collecting from your clients. But of course, it comes with a fee.
Looking at how accounts receivable works, it can actually be a good deal. First is you don’t have to stress yourself collecting the payment since the factoring firm does it on your behalf. However, it is also important to note that there are different types of factoring receivables. In general, small businesses get to have cash advance or the funding that they need to fill in gaps in their cash flow.
How Does It Work?
When you sell your invoices, you get to have the cash advance. It is usually 80% of the invoice amount. Once they have collected the invoice, the 20% is paid to the borrower minus the factoring fee.
There are two types of factoring which include the following:
- Factoring with Recourse: With this type of factoring, there is an understanding between you and the factoring company that your business must get the receivables that the factoring company is not able to get. You cover the cost of the unpaid invoices of your customers.
- Factoring without Recourse: On the other hand, non- recourse factoring is considered to be more expensive. If it is recourse factoring, the fee is 2%. For non-recourse factoring, it is 3%. Non-recourse factoring limits to invoices.If the creditor of the invoice has low credit rating, the factor firm will not shoulder the financial risks.
How to Qualify
To get factoring financing, you need to be qualified by a factoring company or a factoring department of a bank. You will have to submit different documents and other requirements. First is that the factoring company will schedule a personal meeting to discuss your business needs, why you need factoring as well as the business’ support schedules and financial statements.
What You Need to Know About Factoring Fees
Accounts receivables are differently priced by factoring firms. This is what you call a factoring fee. It is a percentage of the receivables that are being factored. There are so many factors that affect the rate that factoring companies charge. Factoring firms assess the industry you are in along with the volume of the receivables. Next, the quality and credit rating of your customers are also evaluated. They also take into consideration the average days outstanding in receivables.
What Are the Advantages of Factoring?
One of the reasons as to why many business firms do factoring is that it offers various advantages which include the following:
- First is that it can give a boost to your cash flow. It does not require a long period of time for you to get the money you need for your business.
- You don’t have to worry too much about the rates since there are lots of factoring companies. The prices are competitive.
- Since factors will deal with your clients, you can actually get essential information about the credit rating of your customers.
- If you are planning a business growth, this is one of the best options to have.
- If you have bad debts, you get to have protection especially if you opt for non—recourse factoring.
- You will get immediate cash that you can use for capital investment really fast.
As with other financing options, it is not all advantages. There are also disadvantages that you have to consider.
- Since you have to pay for factoring fees, it will reduce your profit margin.
- There are factor companies that are strict and will not deal with debtors who have poor credit standing.
- If you want to end your arrangement with a factoring company, you need to pay off the amount that you have already advanced along with the costs.
- There are customers who may not like the idea of dealing with factors.
Receivables Factoring Companies
Choosing a reputable and legitimate receivable factoring company is just one step for you to have a good overall experience. This is very important to avoid experiencing problems later on. How do you choose a factoring company? There are various things that you have to consider.
- Are you looking for an industry-specific factoring company?
- You need to know if the company is offering recourse or non-recourse factoring.
- What are the terms and conditions as well as the fee structure?
- The company should also be able to offer your flexibility. There are companies that actually require long-term contracts and monthly minimum.
- You have to take into consideration customer service. A factor company that gives stellar customer service is easy and professional to work with.
Business owners have the choice as to whether they should go for a traditional bank loan or factor invoices to increase working capital. Your choice depends on what your business needs and your credit score. If you need an instant cash advance, going for traditional loans may not be your best bet considering the documentation and lengthy process. In choosing to go for factoring receivables, you get to have the funds that you need.