Menu
Learn about the flexibility of using your accounts receivables as a source of funding to generate cash for working capital.
Are you a small business owner looking for a reliable and flexible financing solution? Have you heard about financing your accounts receivable but are unsure about how it works and whether it’s the right fit for your business? In this article, we’ll help you understand the two forms of using your accounts receivables to generate cash for working capital.
What exactly is accounts receivable factoring?
Accounts receivable factoring (or invoice factoring) is a form of business financing in which a business sells their accounts receivables, or invoices, to a third-party financial institution called a factoring company. The factoring company buys the invoices and pays the business a percentage of each invoice. The factoring company then assumes the responsibility of collecting the unpaid invoices.
This factoring process is covered by a agreement with a factoring company. The factoring agreement contains key details such as the advance rate, fee structure and other contractual obligations related to the sale of invoices.
What exactly is accounts receivable financing?
Accounts receivable financing is a type of asset-based lending arrangement where a company uses its accounts receivables as collateral for a loan. The total accounts receivables balance is determined, and the receivable loan is based on a percentage of that value. The percentage can vary, but it is typically between 75% and 85%.
Account receivable loans are covered by a loan agreement with a receivables financing company. The receivable loan is set up as a revolving line of credit, but it can also be a simple term loan.
Assignment (or selling) of accounts receivables is the core component of the accounts receivable factoring process. It’s the legal transfer of ownership from your business to the factoring company. Most often, factoring companies receive assignment of all your accounts receivable, even those that you don’t factor.
The factoring company issues a notice of assignment (NOA) to your customer(s) that informs them of the accounts receivables assignment. This allows the factoring company to directly collect payments from your customers.
It’s essential to understand that the assignment of invoices is not a practice of selling your customers’ information or trust. It’s a transparent process so your customers make payments to the correct entity, protecting you, the factoring company, and your clients.
Assessment of accounts receivables as collateral is the core component of accounts receivable financing. This involves evaluating the quality and quantity of the unpaid invoices. The accounts receivable lender will look at factors such as the age of the invoices, the creditworthiness of the clients, and the likelihood of payment.
This assessment is crucial as it determines the amount of loan that the business can secure. If the receivables are of high quality and the clients are likely to pay, the business can secure a larger loan. On the other hand, if the receivables are of low quality, the business may not be able to secure a loan or may get a smaller loan.
Once the assessment is complete, the business can proceed to secure the loan. This involves signing a loan agreement that stipulates the terms and conditions of the loan. The agreement will specify the amount of the loan, the interest rate, the repayment schedule, and the consequences of default.
Contrary to common misconceptions, accounts receivable factoring is not a loan. It does not create any debt or encumber your business with liabilities. You’re not borrowing money, but strategically managing your cash flow by selling assets you already own. It’s a powerful financial tool designed to enhance your business’s growth and stability without the burdens often associated with traditional loans.
Factoring encompasses a broad range of services in addition to just paying advances on invoices. Factoring companies perform the following services:
Factoring, in essence, is a partnership between a business and the factoring company dedicated to helping the business’s success.
First, you need to operate a B2B (business-to-business) enterprise, as factoring is designed for trade credit transactions between businesses.
Second your customers should have a strong credit history, as the factoring company relies on their financial stability to ensure payment.
Last, your business should be free of liens and legal issues.
When it comes to getting approved for factoring your receivables, the process is usually straightforward and much more lenient than traditional bank financing. Factoring companies evaluate the following criteria for determining eligibility.
It is important to note that while these criteria are common, each factoring company has its own specific criteria for determining eligibility. Some lenders may place more emphasis on certain factors over others, depending on their risk appetite and industry focus.
In most cases, approval comes through in a matter of days or weeks. The process typically includes an application that outlines your personal credit, customers and outstanding balances, legal business details, and company liens or encumbrances.
Navigating the complexities of business transactions requires meticulous attention to detail, especially when it comes to UCC (Uniform Commercial Code) filings and liens. The filing of a UCC lien is a standard requirement for many financial transactions, especially in factoring. A UCC lien provides a legal claim on assets in the event of a default on a loan.
One of the first things a factoring company will do when evaluating your business for factoring services is to perform a UCC search on your business. A UCC search provides critical information about any existing liens on assets that you may be intending to use as collateral. It serves as an essential tool for protecting the factoring company against unforeseen financial complications. By identifying any existing liens on your assets, the factoring company ensures that your financial transactions remain unencumbered and within legal bounds.
Once your business is cleared of any existing UCC filings, the factoring company will file its own UCC lien on your company’s receivables. The ultimate objective of the UCC search and filing process is for the factoring company to be in a first position on your accounts receivables.
A factoring agreement is a crucial and legally binding document that is integral to the success of your relationship with the factoring company. It outlines the specific terms and conditions under which the factoring transactions will be conducted, and it is vital, therefore, that you understand all its components thoroughly.
The agreement typically covers key details such as the advance rate, which refers to the percentage of the invoice amount that you will receive upfront, and the fee structure which determines the cost of the factoring service. It also includes terms like the length of the contract, invoice volume commitments, and the process for handling delinquent accounts.
The factoring agreement will specify who bears the risk of loss if a customer can’t pay an invoice. Recourse factoring, the more common and cost-effective of the two, places the burden of non-payment on the business. If an invoice isn’t paid within a pre-determined timeframe, the factoring company retains the right to sell the invoice back to you.
On the other hand, non-recourse factoring absolves you of the liability for bad debts. If a customer fails to pay the invoice for credit reasons such as insolvency or bankruptcy, the factoring company assumes the loss. It’s an attractive option, undoubtedly, but it comes at a premium. The factoring fees are higher to compensate for the increased risk taken on by the factor.
A/R factoring can be a valuable tool in many scenarios, including:
If your business is experiencing cash flow gaps due to delayed payments from customers, factoring finance can provide immediate funds to bridge the gap.
Businesses that experience seasonal fluctuations in demand can use factoring finance to access working capital during the off-seasons.
Factoring companies must evaluate the risk of factoring your receivables. They analyze your customers' credit as well as your business situation. If they determine the risk is too high, then you may not get approved.
As your business expands, managing cash flow becomes critical. A/R finance can help fuel growth by providing the necessary funds to meet increasing operational demands.
Accounts receivable factoring is much easier and more practical for small businesses than accounts receivable financing.
Factoring application and approval doesn't take long. A business can get funded in a matter of days or weeks, not months.
Factoring is often a bridge to more traditional forms of financing such as accounts receivable financing.
Ready to take control of your cash flow and start factoring your invoices? At FactoringClub, we understand accounts receivable factoring and we’re dedicated to guiding you through the process with ease.
Our expert team is committed to connecting you with the most suitable factoring partners, saving you from the time and hassle of choosing the right factoring company.
Don’t let the challenge of finding a factoring partner hold you back. Get started today and let FactoringClub help you find the perfect factoring company for your business.
Accounts Receivable Factoring: A Comprehensive Guide In today’s business world, managing cash flow is crucial for the success and growth of any company. One financing option...
What is a Factoring Company A factoring company, also known as a ‘factor’, is a third-party firm that businesses can use to manage their accounts receivable....
Birmingham Alabama
Business Services Manufacturing Staffing
SVP National Sales
Monmouth Beach New Jersey
Business Services Manufacturing Staffing
President
Miami Florida
Healthcare
Account Executive
Dallas Texas
Business Services Manufacturing Oil and Gas Staffing Trucking
SVP, Director of Sales
Medford Oregon
Trucking
Sales Manager
Jonesboro Arkansas
Trucking
Owner