Accounts Receivable Financing: What to Know

As a small business owner there are times when you need additional cash flow quickly to pay employees and vendors.  You have invoices to be paid from your customers, but those due dates could be weeks or even a couple of months away.  A small business loan can take weeks or months to funds which is not helpful when funds are needed quickly.

How Does Accounts Receivable Financing Help Cash Flow?

The biggest benefit of using accounts receivable financing is being able to obtain cash quickly for your business. 

Accounts receivable financing involves selling your receivables to a factoring company (or “factor”) that in turn provides immediate funding to that business as a percentage of the invoice amount. Subsequently, the business’ customers remit payment for those invoices directly to the factoring company.  Upon collection, the factor funds the balance of the invoice less their fees back to you.

This form of financing is particularly helpful for businesses that have large invoices from customers that may pay slowly or for larger corporate clients that may have extended terms such as 60 to 90 days.   

Accounts receivable financing provided a much needed cash injection when cash flow gets tight as you wait for your customers to pay.

Does My Business Qualify for Accounts Receivable Financing?

Accounts receivable financing is becoming increasingly more popular and widespread, particularly with small businesses that are unable to qualify for traditional financing. 

The primary qualification for accounts receivable financing is that your business must sell a product or services to strong, creditworthy customers, extend payment terms, and that the invoice can be verified by the customer. 

Generally, as long as your company sells business to business, almost any industry can qualify for accounts receivable financing.

How Does Accounts Receivable Financing Work?

•  Your company receives an order for goods or services from ABC Customer and your company performs the services or ships the goods to ABC Customer.

• Your company sells the invoice to a Factoring Company and the ownership of the receivable has now been transferred to the factor.

• Factoring Company sends the invoice to ABC Customer (on behalf of your company) and obtains the right to receive payment from ABC Customer.

• The Factoring Company immediately advances funds to your Company at a specified percentage of the face value of the invoice (typically, this amount is between 80% and 85% of the total invoice amount).

• ABC Customer remits payment directly to the Factoring Company.

• Factoring Company then remits the “reserve” less the factoring fees to your Company.

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, accounts receivable financing can have a tremendous impact on cash flow by providing immediate funding to support your business. 

However, as you look at different factoring companies, here are 4 things you need to know.

1. Contract Fees.  All factoring companies charge a “factoring fee” which is typically 1% - 3% of the invoice amount.  Watch for hidden fees such as collateral management fees, administrative fees, audit fees, or minimum monthly volume requirements which can have a substantial impact on your overall financing costs.
2. Contract Terms.  Understand how long you will be locked into the factoring agreement and make sure the timeframe works for your cash needs.
3. Volume requirements.  Some factoring companies require that your business sell all of your invoices to them while other factoring companies let you pick and choose the invoices you want to factor.  Additionally, some factoring companies have minimum volume requirements that must be met each month.
4. Recourse vs Non-Recourse.  Recourse means that if your customer does not pay an invoice, you will be responsible to buy your invoice back from the factor.  Non-recourse means that if your customer does not pay the invoice the factor assumes the debt.  Non-recourse factoring is typically more expensive than recourse financing due to the additional risk.

If you have any question give one of our cash flow specialists a call at 888.833.2286.