An accounts receivable loan, more commonly known as factoring, has unfortunately earned a negative reputation despite the fact that it is one of the oldest forms of financing in the world. The misconceptions about factoring are the result of not understanding how factoring works and the benefits that an accounts receivable loan provides.

How Does an Accounts Receivable Loan Work?

A company’s accounts receivable is typically its largest asset. A factoring company (or “factor”) purchases a business’ invoices and provides immediate funding to that business at a rate up to 85% of the invoice amount. Subsequently, the business’ customers remit payment for those invoices directly to the factoring company. The factor then sends the remaining funds less the factoring fees back to the client.

Three Common Factoring Myths

Myth #1:  Factoring is Too Expensive

Financing receivables at a discount to get immediate funding for your company is a cost-effective way to improve cash flow.  Utilizing factoring to fund new growth, meet payroll costs, or purchase supplies is much less expensive than the alternative of raising equity which is the most expensive form of financing new growth or meet working capital requirements, not to mention having to possibly give up a portion of ownership.

Factoring is typically more expensive than a traditional bank loan. However, for a small business that is unable to qualify for traditional financing, the additional expense will generally outweigh the alternative of not taking on new business or not meeting payroll obligations.   

One tip when reviewing the cost of factoring is to know all of the fees that are involved.  There will always be a fee based on the invoice amount that is purchased, but you should also look for other fees such as collateral management fees, minimum discount fees, and field exam fees for example.  These additional fees can have a huge impact on your cost of funds.

Myth #2:  Using a Factoring Company is For Businesses That Have Serious Cash Flow Problems

Although factoring can be used by companies to get through difficult financial periods, using factoring to finance your business is not a sign of financial weakness.  Actually, financing receivables shows that your company is carefully managing its finances and is preparing for stronger future growth. 

Many large companies with revenues exceeding $100 million a year use factoring. Factoring is not a sign of financial distress, but of ensuring that your company can meet its obligations.  Factoring is quick and more flexible that traditional forms of financing. Additionally, a factoring company helps business owners collect payments in a timely manner and is able provide credit information on prospective customers.

Myth #3:  If I Use a Factoring Company, I Will Lose Customers

This myth is very closely tied to Myth #2.  In reality, your customers generally do not care where you are obtaining your financing as long as your company continues to deliver a superior product or service. If you feel there may be this misconception, the best thing to do is to call your customer and explain that you are entering into a financing relationship XYZ Company. The only change that impacts your customer is the getting payment direction changed to the factoring company. 

Factoring companies want their clients to grow and do more business, so it is not in their interest to alienate your customers. Reputable factoring companies are professional in dealing with your customers and making the process as easy as possible for all parties. In most cases, your customer will not notice much of a difference in your relationship with them.

Benefits of Financing Receivables                       

If you are a small business where your accounts receivables is one of your largest assets and have a strong, credit-worthy customer base, but are having to wait 30, 60, or even 90 days to get paid, factoring can have a tremendous impact on cash flow by providing immediate funding to support your business.

• Fast - Once you have a line in place with a factoring company, you typically receive funding within 24 hours.

• Flexibility - Some factoring companies allow you to pick and choose the customer and invoices you want to factor.  This gives you the choice of factoring all of your invoices for a steady and consistent stream of cash coming in or submitting invoices when extra cash is needed to cover payroll.

• Short-term – Factoring facilities are short-term in nature so you are not indebted to a lender for a significant period of time.