Accounts Receivable Factoring is a form of financing that gives a business access to capital that is tied up in their outstanding A/R. This type of financing is a line of credit like facility but takes place when the business sells its invoices to an invoice/ accounts receivable factoring company. The invoices are then removed from the seller’s books (or the company receiving the financing) and are then added to the factoring company’s balance sheet at their fair value.
The factoring company would be buying these accounts receivable at a discount rate and then waiting on their client’s customers to pay the invoices, whether that be in 30, 60 or 90 days.
The discount amount depends on a number of different factors, such as the dollar amounts of the invoices you are selling, how long it takes for your clients to pay, how credit worthy your customers are and which factoring company you choose. This rate can vary from under 1% of the invoice value up to 3 or 4%.
Note: All advance rates, discount rates or fees are agreed upon in advance while being set up.
Step 1: The seller submits their invoices to the factoring company along with any backup they may have to substantiate the invoice. Once the factoring company is able to verify in some way that the invoice is good, they typically advance 80% to 95% of the amount of the factored invoices the same or next day. For example, if you sell $100,000 worth of accounts receivables and get a 90% advance, you will receive $90,000.
Step 2: The accounts receivable factoring company holds the remaining 10% or $10,000 as security until the payment of the invoice or invoices has been received.
Step 3: The factoring company collects payment over the next 30 to 90 day period depending on the customer’s payment terms.
Step 4: Once the payment has been received, the factor pays you, (the seller of the invoices), the remaining 10% less the factoring fee, which typically runs 1% to 3% of the total invoice value.
Simply put, Yes! There are many things to consider when looking into different factoring companies. Even though each factoring company is offering a similar service, there are many points that differentiate them. Each factoring company will have different funding rates, advance rates, contract terms and requirements. Some factors will require a personal guaranty, or maybe will require you to factor all invoices that the company produces, and other factoring companies will let you pick and choose.
Many factoring companies also have certain industries that they specialize in. With this added knowledge, these factoring companies will more likely understand your industry, giving you added flexibility, generally better rates, and be a better partner overall. So ask the factoring company, which industries they specialize in before making your choice of factors.
Lastly, find a factoring company that treats you like a partner. Find one that understands what you do, does not stifle your growth, but gives you the necessary capital and partnership to enable the growth of your business.
Factoring fees can come in many different shapes and sizes. So the main thing you need to make sure of is that you understand what fees are going to be incurred by doing business with a factoring company. So make sure to ask the question. Fees can be charged as a percentage of the invoice value, they can depend on how long the invoice remains unpaid, there can be wire and ACH fees, there can be administrative fees, interest fees and the list goes on. Make sure you read the contract and understand all of the fees in with you are going to be charged so that you can make a smart decision about which structure is the best and most cost effective for you.
The two most common fees charged are flat fees and tiered rate fees. Here is a quick explanation on how they typically work.
Flat fees are really just how they sound. They are when a factoring company charges a one-time flat discount fee for the factoring of the invoice regardless of how long or how quickly the invoice is paid. This can be great, as it provides an upfront knowledge of exactly what your finance costs are going to be, but it can also prove expensive if your customers generally pay quickly. If a factoring company charges a 3% flat rate and your clients pay in 60-90 days, well then you are getting quite a good deal, but if 3% is charged and most of your clients pay in 7-30 days, well 3% is a lot for such a short time. So, look over your customer list or aging and think about how long on average it takes for your customers to pay and that will help you in determining whether a flat rate really is a good deal for you or not.
Tiered fees are fees that incrementally increase as the invoice remains unpaid. This is great because you are only incurring fees for as long as it takes the invoice to be paid. Especially if your customers are paying quite quickly, then tiered fees will generally save a business a lot of money on factoring costs. To learn more and see an example of our page comparing different factoring fees, click here
In short, No. Accounts receivable factoring companies are actually purchasing invoices at a discount rate thus transferring the assets or invoices to their balance sheet. Although there are certain circumstances where a factoring company can ask for the money back, in most cases a factoring company will be the one collecting on that invoice because the client will have already received the factored capital well in advance. This gives them the needed cash flow to fund and grow their business.
Qualifying for invoice factoring is pretty simple. If the factoring company can understand a simple set of facts, then generally qualifying is not an issue. Here are the two main things an accounts receivable factoring company needs to understand:
If these things can be determined along with the fact that a business has some “going concern” or the business is not likely to go bankrupt, then typically they will be a candidate for accounts receivable factoring.
Factoring does not require a certain credit score, nor require years in business, and neither is it decided upon by a computer algorithm. For this reason, invoice factoring has proven in its different forms over the centuries, that it is a very valuable tool for a growing business that needs a finance partner to improve cashflow.
There are many benefits to accounts receivable factoring that make it a great financing choice for a growing business. Here are 7!
There are times when factoring is not a great fit as a finance solution for a business and a company would be better off pursuing alternative types of financing. Some common reasons are:
A factoring company is knowingly taking on credit risk, or the risk of the customer being able to pay the invoice or not, but an AR factoring company does not want to take on the risk of production. As a factoring company cannot take on a project their client is working on and complete it for them, the factoring company will want to make sure that the job is done before purchasing an invoice. If the invoice is billed before the service is complete, then a factoring company would not be able to purchase or fund against it. In the same way, if an invoice is submitted for a service that is only partially completed then the same problem would arise.
As a factoring company is purchasing invoices primarily based on the credit-worthiness of a business customer, they are unable to purchase invoices that are to an individual. Factoring companies are a good fit for companies that have business-to-business or business-to- government receivables.
There are many businesses that simply do not have accounts receivable. Many software companies require payment before any service is rendered and many other types of businesses require up-front payment before starting any work. As accounts receivable factoring companies are basing their funding on outstanding AR, if there is none, there is no factoring. Plain and simple, these businesses would not be a good fit for an accounts receivable factoring company.
Non-recourse factoring typically comes up for two reasons: 1) Because many factoring companies advertise this type of financing ; and 2) Because factoring users do not want to have a factoring company come back to them and ask for the money back if their customer does not pay the invoice.
In most cases, the risk a factoring company is assuming with a non-recourse factoring agreement, is in the event that the account debtor or customer declares bankruptcy within the 90 day period from the time the customer was invoiced, then the factoring company would not ask for the money back.
The exact terms of non-recourse factoring will vary from company to company, so make sure you understand under what circumstances in the non-recourse factoring arrangement the factoring company would ask for their money back.
B2B start-up businesses that are soon to begin billing customers or are generating invoices can partner up with a factoring company and utilize them to finance their growing start-up. The factoring company can help by:
Factoring companies are very different from traditional banks. Factoring companies look to the credit quality of the business' customers, allowing even a start-up business to get set up pre-revenue and ready to receive working capital as soon as they invoice a credit-worthy client.
At Meritus Capital, we are always working at making the on-boarding process as quick, easy and seamless as possible. Here are a few key points about the process.
An accounts receivable factoring broker is someone that refers business to a factoring company and receives a commission for doing soon. This industry is unregulated and can create a great residual income for someone that is connected in a particular industry. If you would like to find out how you can start, please reach out to us today.
Meritus Capital is happy to answer any additional questions or speak with you regarding how we may be able to help you start utilizing accounts receivable factoring. Sign up today or call us at 1-877-648-3709. We have helped hundreds of companies across the USA and Canada for almost 20 years. Reach out today!