Accounts Receivable Factoring: How Can it Help Expand my Business?
Let’s start with what it is not; accounts receivable factoring is NOT a business loan with interest and payments due. You or your company are not ‘borrowing’ money.
You are in fact selling an asset at a discount to a third party in exchange for immediate cash. When we define factoring it is important to remember the business asset you are selling is an account receivable between you and another business. If you sell to consumers (like a retail store or restaurant) there is a different method to use, called credit card factoring, which we will discuss in another article.
Essentially you are using accounts receivable factoring to improve your cash flow. When you have a business or commercial customer with a good credit history, you can start invoice factoring immediately – even if your business is new or has issues with it’s credit score factors.
What is a Factor?
The ‘Factor’ is the bank or private receivable factoring service you use to handle your invoice financing or AR financing.
Each ‘Factor” entity has it’s own terms, conditions and rates for your accounts receivable factoring and providing your Purchase order funding. Some offer both recourse and non-recourse receivables factoring. Some allow you to choose which invoices to send to them – others require all the invoices from a particular customer. Some have large minimum invoice sizes and other have none.
The message from your Business Mentor here is to understand everything the Factor offers and try your best to match that with your working capital needs.
Who can use Factoring?
Your Business Mentor – Ray, ran an accounts receivable factoring company for many years. I fully understand the demands for cash flow in new and growing businesses. Let’s look at some of the typical uses of the funds from selling your invoices at a discount to factoring companies.
Cash flow for; meeting payroll, buying inventory or parts, paying taxes (the cost of small business factoring is MUCH less than the IRS fees for late tax payments), funding a marketing campaign, purchase new machinery, expansion opportunities.
If you sell to larger firms many of them take 30, 45, 60 or as much as 90 days to pay. Their credit worthiness is excellent – they just take time to process payments.
For the average small business getting these larger customers usually is a very good thing. Larger sized businesses generally make larger orders.
Larger orders that take longer to collect on means cash flow problems for you. Your small business must buy inventory and make payroll while still filling these orders. Working capital is depleted.
So … if you are a legitimate business, selling to credit worthy commercial customers … you are eligible to usee accounts receivable factoring to improve your cash flow.
How Much Does Business Factoring Cost?
Like all things in business – it depends. You can find a factoring calculator online, but the following items really will drive the cost of your particular situation.
- Your Industry
- Your customer’s creditworthiness (not your credit worthiness)
- How long it takes to get payment from your customers
- The dollar size of your factored invoices
If you are in an industry where factoring is commonly used , such as trucking or medical accounts receivable, then the rates are going to more competitive than say international accounts receivable factoring.
The range of the discounts you can expect are from 1.5% to 5% of the invoice face amount for each 30 days it outstanding. Your factoring agreement will have very specific terms and conditions and you should make sure you fully understand them.
Factoring Examples: What works and Why
You sell your product or products to a credit worthy customer, as soon as the invoice is produced and confirmed the following happens:
- Issue invoice to Customer ABC Corp for $1000
- Submit invoice to Factoring Company
- Within 24 hours 75% ($750) of the face amount of the invoice is wired into your business bank account
- Customer ABC Corp pays the invoice ($1000) to the Factor in 30 days in full
- The factor keeps the $750 advance it made to you
- The factor keeps it’s 5% fee ($50)
- The factor pays the balance of $200 to you to close the transaction out.
This is very simplified, but gives you an understanding of what is happening. Many companies factor invoices daily – others do it once a week or once a month.
What will my Customers Think?
Many business owners are reluctant to factor their receivables because they think their customers will think they are in financial trouble or at risk if going out of business.
Actually larger companies themselves use AR factoring all the time and all they know is that you are asking them to send the payment to a different address. Of course with some smaller businesses it may make sense to discuss this with the owner to assure them that you are doing factoring to help you grow and to serve them better.
Purchase Order Factoring:
Can I use factoring to fund a large Purchase Order?
Purchase Order Funding is a something that many factoring companies and factoring banks are happy to do. It is similar to accounts receivable factoring with some exceptions. The factor may release funds for work to you for work in process with multiple disbursements, depending on the time line to shipment. These situations are handled on a case by case basis, so be sure to discuss this with your factor.
Your Business Mentor believes that Accounts Receivable Factoring and Purchase Order Funding are terrific ways to improve your cash flow. They should be tools used to help over tough spots and to help fund growth. They should never be used continually year after year as the fees come directly out of your profit margin.
The History of Factoring
When the Pilgrims came to America, a factor in England funded the journey. They traded passage for the timber and furs returned to England on the ships. Once the colonies were settled the factoring continued to fund the shipment of finished good to America for the Pilgrims to sell in their shops.
Today factoring is an enormous business that had its roots in the garmet industry in NYC in the early 20th century. Clothing firms still make extensive use of factoring to fund their receivables.
Now most factors use the Internet to process and report on transactions. This has lowered the cost of doing business and allows for factoring companies to serve the small business owner, and those smaller sized receivables.
Cash flow is the life blood of businesses and factoring has played a huge role in financing businesses today.
In the 21st century Accounts Receivable Factoring is filling in the void for business credit created by the banking crises of 2008 and the current recession.