Accounts Receivable Factoring: An Easy Way To Free Cash From Unpaid Bills
If your business faces cash flow challenges, accounts receivable factoring may be the ideal solution to the problem. With accounts receivable factoring, you sell your accounts receivables or invoices to generate fast cash. Accounts receivable factoring is a common practice that companies around the world have used for centuries to manage cash flow. In fact, accounts receivable factoring transactions in the United States alone exceed $ 60 billion a year, according to the Trade Finance Association.
Benefits of accounts receivable factoring
There are a number of benefits to accounts receivable factoring. One of the main reasons is that it gives you the ability to immediately access the cash owed to your business. For some businesses, this minimizes the need to incur operating debt while waiting for bills to be paid.
Another advantage of factoring is that it provides a smoother and more uniform cash flow. Rather than wondering if or when you will receive payment from your customers, you can accurately predict when you will receive payment based on the terms of your relationship with the accounts receivable factoring company. Typically, companies must wait 30, 60, or even 90 days to receive payment for invoices for products or services that have been delivered. During this time, these funds are immobilized and inaccessible to the company. However, accounts receivable factoring can eliminate long billing cycles and improve cash flow.
Also, factoring eliminates the need for you to manage your own collections. Factoring companies are run by professionals who specialize in collecting and tracking invoices. This translates to an overall reduction in bad debt and fewer headaches for your business.
Accounts receivable factoring can give you access to cash within 24 hours, which can help you effectively deal with short-term cash flow problems. It can also help you:
o Accelerate cash flow, facilitating payroll, paying taxes and fulfilling new orders.
o Offer better conditions to large clients and increase sales.
o Extend credit to large customers without asking for COD.
o Pay your providers faster; take advantage of discounts for prepayment.
o Purchase of equipment, inventory and supplies.
Qualification for factoring accounts receivable
Almost all types of industries that generate business invoices can and do use accounts receivable factoring. In general, if you pay for labor or materials before receiving payment from your customers, factoring can help your business. Or if your business is growing faster than you can generate additional working capital, from private sources or from a bank, factoring can probably provide you with the cash you need for steady growth. Also, if you have a relatively new business that cannot qualify for bank financing, factoring may be ideal for you.
To qualify for accounts receivable factoring, your business will need to meet two basic conditions. There can be no existing primary links on your invoices, which means that no other business should have a claim on payments when they come in. Furthermore, your clients must also be creditworthy. The factoring company will evaluate its clients based on how quickly they are likely to pay their bills.
Top Candidates for Accounts Receivable Factoring
Is Your Business A Top Candidate For Accounts Receivable Factoring? Accounts receivable factoring may be the perfect solution if:
o Long billing cycles are putting pressure on your business cash flow.
o Do you spend too much time fundraising from slow paying clients and don’t have enough time to build your business?
o The bank has denied your application for a traditional loan due to lack of years in business, profitability, assets, or overall financial strength.
o Your company could increase sales by offering better conditions to its new and larger customers.
On the other hand, accounts receivable factoring may not be a good option if your business is running on low margins, less than 10 percent. Accounts receivable factoring will also make no sense for your business if you have ample working capital and cash flow is not an issue.
How does it work
With accounts receivable factoring, you essentially settle or sell outstanding invoices to a factoring company to receive immediate working capital. The company buys the invoice from you for a cash advance amount slightly less than the face value, and then collects the full amount when the account receivable is due. Once the factoring company receives full payment of the invoice, you will receive the remaining amount, less a fee. Generally, the accounts receivable factoring fee is three to five percent of the invoice value.
Factoring companies have different fee structures, but factoring fees generally involve:
o Advance Financing – When you submit an invoice for factoring, you will generally receive financing for 70 to 90 percent of the invoice amount within 24 hours of invoice verification. The advanced financing is then transferred to your business bank account.
o Discount rate or factoring fee: The factoring fee can range from 2.5 percent to 3.5 percent for 30 days, or .1 percent for each day the invoice is not paid after factoring. (Factoring rates can be customized based on the individual needs of your business and customer base.)
o Rest of the advance minus the factoring fee: When your customer pays the invoice, you will receive the rest of the advance financing, less the factoring fee or the discount rate.
Here’s an example of how accounts receivable factoring works. Suppose you have a customer from company XYZ, who owes your company $ 100,000 for a shipment of their newly delivered devices. XYZ Company is a great customer who has good credit, but never pays your vendors (you) before 45 days. Instead of waiting 45 days to get paid for your $ 100,000, you decide to take advantage of accounts receivable factoring. The factoring company verifies your invoice to the XYZ company and you receive 80 percent of the $ 100,000 ($ 80,000) within 24 hours, transferred to your bank account.
If you have a discount rate similar to the one given above and Company XYZ pays the $ 100,000 bill in approximately 45 days, this equates to a factoring fee of 4.5 percent of the original $ 100,000 ($ 4,500). Since you already received an advance of $ 80,000 from the factor, you will receive the remaining $ 20,000 less the factoring fee of $ 4,500 ($ 15,500). Ultimately, you will collect $ 95,500 of the original $ 100,000 bill.
Keep in mind that the percentage that an accounts receivable factoring company charges is generally more than what you would pay for a short-term business loan. For that reason, factoring is best used to generate quick cash, not as a long-term solution. Additionally, accounts receivable factoring companies make money based on the volume of invoices they purchase. So, you may find it a bit more difficult to find a factoring company if you have bills of less than $ 10,000.