What is Accounts Receivable Factoring?

by Paul Deluca

At its very basics, Accounts Receivable Factoring is a form of financing that gives your business access to capital that is tied up in your outstanding A/R.

This type of financing is a line of credit like facility but takes place when your business sells its invoices to an invoice/accounts receivable factoring company, like Meritus Capital. The invoices that you have chosen to sell are then removed from your books and added to the factoring company’s balance sheet at their fair value.

The factoring company buys these accounts receivable at a discount rate and then waits on your 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 one-percent of the invoice value up to three or four-percent.

When you are looking for a factoring company, these are the numbers that you need to take into account to make sure you are getting the best rates possible. Our rates are listed here.

In this article, we take you through all the information you need to know about Accounts Receivable Factoring.

How Does Factoring Work?

To help you better understand how factoring works, we’ve laid out the steps involved in the overall process below:

Step 1: Invoice Submission
You submit your invoices to the factoring company along with any backup you may have to substantiate the invoice. Once the factoring company is able to verify that the invoice is good, they typically advance 80 to 95 percent 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 percent advance, you will receive $90,000.

Step 2: Accrued Reserve
The accounts receivable factoring company holds the remaining 10-percent or $10,000 as security until the payment of the invoice or invoices have been received.

Step 3: Payment Collection
The factoring company collects payment over the next 30 to 90 day period depending on your customer’s payment terms.

Step 4: Final Payment to Seller (You)
Once the payment has been received, the factor pays you (the seller of the invoices), the remaining ten percent, less the factoring fee, which typically runs one-percent to three-percent of the total invoice value.

Please note:
All advance rates, discount rates or fees are agreed upon in advance while being set up.

What to Consider When Choosing a Factoring Company

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 guarantee, 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. Ask the factoring company, which industries they specialize in before making your choice of factors.

It’s also important that you 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.

Here’s an example of a company who made sure they were choosing a factoring company that treats their clients like partners instead of just another customer:
"The entire team at Meritus Capital are heroes. I had an oil field company that was starving for cash flow due to oil companies paying net 60 and 90, we were a new company and the banks were not supportive. Meritus provided us a very simple process of turning our invoices into cash, reducing the waiting cycle from 12 weekly cycles to 1 week. Because of Meritus we took a small company from 900,000 to 17,000,000 in a very short period," said Lee Washington after working with Meritus Capital.

How Do Factoring Fees Work?

Factoring fees can come in many different shapes and sizes. 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. Make sure to ask the right questions! Here are some ways in which fees can be charged:

  1. As a percentage of the invoice
  2. They can depend on how long the invoice remains unpaid
  3. There can be wire and ACH fees
  4. Administrative fees
  5. Interest
  6. and much more

Make sure you read the contract and understand all of the fees in which 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.

Flat Fees Versus Tiered Rates

The two most common fees charged are flat fees and tiered rate fees. Here is a quick explanation on how they typically work.

1. Flat Fees
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 three-percent flat rate and your clients pay in 60-90 days, well then you are getting quite a good deal. But, if three-percent is charged and most of your clients pay in 7-30 days, well three-percent is a lot for such a short time.

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.

2. Tiered Fees
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. 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

Is Accounts Receivable Factoring a Loan?

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.

How to Qualify For Factoring?

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:

  1. Is this a business to business (B2B) or business to government (B2G) invoice for a product or service that has been delivered or completed?
  2. Is the account debtor or customer able to pay the invoice?
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, it does not require years in business, and it is not decided 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 cash flow.

How Invoice Factoring Benefits Your Business

There are many benefits to accounts receivable factoring that make it a great financing choice for a growing business, such as:

  1. No repayment that impedes cash flow
  2. No real limit - outside of good paying customers
  3. Not based on number of years in business
  4. Good for start-ups, medium and large-sized businesses
  5. No requirement to factor if you do not need to
  6. No hard cost to getting set up
  7. Rapid approval and funding

Why Some Businesses Don't Qualify

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 include:

Pre-Billed or Progress Billed Invoices

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, 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.

Businesses That Solely Invoice Customers

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 B2B or business-to- government (B2G) receivables.

Businesses Without Accounts Receivable

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.

What is Non-Recourse Factoring?

Non-recourse factoring typically comes up for two reasons:

  1. Many factoring companies advertise this type of financing
  2. 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, the factoring company would not ask for the money back.

The exact terms of non-recourse factoring will vary from company to company. Make sure you know under what circumstances in the non-recourse factoring arrangement the factoring company would ask for their money back.

Is Invoice Factoring a Good Option for Start-Ups?

B2B start-ups that are soon to begin billing customers or are generating invoices can partner up with a factoring company and utilize them to finance their growth. The factoring company can help by:

  • Providing credit insights for new customers, helping businesses make smart decisions
  • Putting working capital into the hands of a business owner
  • Giving you access to funds that grow as you grow

They also take no equity with the funding. Factoring companies are very different from traditional banks. Factoring companies look at 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.

How to Sign Up with an A/R Factoring Company?

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.

  1. We have a quick and easy online application that can be filled out and where select documents can be uploaded
  2. Once we agree to the basic terms, we will provide you with a contract to sign
  3. We can go from start to funding sometimes in as little as a few days to a week

What is a Factor Broker

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!

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