All You Need to Know About Accounts Receivable Factoring Companies

It is not out of the ordinary for a business to forego payments for some time before requiring customers to pay for goods supplied.

As a result, you may find the business is booming, but you are short on cash since most customers are paying on credit. Consequently, you will have inflated accounts receivables due to the unpaid invoices.

Such a situation may present a problem if the customers pay late or you have lengthy net terms since you have to cater to operational costs, such as payroll, fuel, and emergency expenses. Therefore, some companies have resorted to enlisting the help of invoice factoring.

If you are looking for ways to improve business cash flow, here’s what to look for in accounts receivable factoring companies. One of the best alternatives to invoice factoring companies is Resolve. They are a complete B2B payments solution that helps business owners, wholesalers, distributors, and manufacturers manage their net terms risk and improve cash flow.

What is an accounts receivable factoring company?

According to Payments Journal, 46% of small businesses reported consistently receiving late payments for goods supplied to customers.

A Fintech Times report noted that most customers pay small businesses 30 days later than more prominent suppliers, often starting invoice processing 35 days after receipt.

Therefore, some businesses have had to look for ways to fill the cash flow gap by turning to factor companies.

Accounts receivable factoring refers to the practice of exchanging invoices for upfront cash. Thus, a factoring company, otherwise known as a factor, engages in a service known as accounts receivables or invoice factoring lines of credit.

That involves paying 80-95% of the unpaid invoice/accounts receivable face value as they wait for your client to pay at a predetermined future time.

After full payment, you will receive the remainder of the invoice amount, less the factoring fees.

How factoring works

Let’s say you’ve sold goods worth $50,000 to a client. If the factor is willing to buy it at 90% of the value, this is how you would typically conclude that transaction:

On acceptance of your invoice, the factor will send $45,000 at that moment.
The invoice factoring company will hold the $5,000 balance in reserve.
Their weekly factoring fee of 0.75% translates to $375.
If the customer repays after one month, the factoring will be $375 multiplied by four weeks= $1,500.
The factor will then deduct the $1,500 from the held reserve and send you the $3,500 balance.
Therefore, you will receive $48,500 in total, while the factor’s service charge is $1,500 for the same invoice.

Kindly note that this is a hypothetical scenario as some factors charge lower or higher fees, with some even offering discounts if the customer pays earlier than anticipated.

Difference between invoice factoring and invoice financing

Although both are business financing options, invoice financing is a business loan. On the other hand, accounts receivable factoring is the sale of outstanding invoices.

In short, if you settle on invoice financing, the bank will issue you a loan based on the value of the outstanding invoices. After that, you will make regular monthly payments like any other bank loan, and you are free to collect the invoice amount from the customer.

As for invoice factoring, you sell the invoice for a cash advance at a discount and wash your hands off that invoice. Unless otherwise, the factor will follow up on payments and collect the cash from your client.

Why would anyone use a factoring company?

Sure, it seems a terrible idea selling an invoice for less money, but you might encounter an emergency that requires more cash than is available.

That will force your hand into selling a few invoices to settle short-term debts. That might not be ideal, but instant cash can help boost cash flow whenever needed.

For instance, you may sell goods worth $100,000 to a customer, payable after 60 days. If you must pay one of your suppliers $60,000 after 30 days and you have no cash when it is due, you might sell the $100,000 invoice to a factor for $95,000. The accounts receivables company will then pay you to aid in clearing the pre-existing risk.

When might a business need to use an accounts receivable factoring company?

These are the types of situations that a business would most likely find themselves resorting to invoice factoring:

Bad credit: bankers will not be willing to lend you money if you have bad credit history. Your best shot at financing would lie with an accounts receivable factoring company.
Want to avoid debt: with invoice factoring, you are selling an asset, not taking on a loan. This has a different impact on your company’s balance sheet compared to invoice financing or a loan.
Startups or small business owners: since these businesses have an unconvincing credit history, they have a better chance with a factoring company than conventional lenders.
Growth outstrips cash flow: you may finally see your company achieve the growth you have always dreamed of, so you embark on an ambitious growth plan that outpaces your cash reserves. While bankers may see your strained cash flow position as a red flag, a factor has no problem as long you keep invoicing.
Recovering from financial issues: if you are picking up the pieces of a bankruptcy, or are up to your neck in tax liens, no banker will offer you working capital. A factor can if you have viable invoices.

Industries that use invoice factoring

Invoice finance companies cover most B2B (business-to-business) and B2G (business-to-government) customers and they love industries with extended net terms, including:

Trucking companies
Construction
Staffing services
Manufacturing
Distribution
Consulting
Retail
IT service and software development

How to choose the best factoring companies

Since you are facing a cash crisis, it is easy to overlook crucial aspects of a contract when entering an agreement with a lender who is offering cash relief at such short notice. These are the best steps to take when considering an accounts receivable financing company:

a. Pricing

Since factoring is another way of lending money to businesses, the services will come with a factoring fee, also known as a discount rate. The costs are dependent on different aspects and calculation, such as:

The industry
Your client’s credit scores
The average invoice value
The invoice net terms
The number of invoices you are willing to factor in a month

The typical factoring rates are between 1-5%, but you will likely receive a discount if your customers pay their invoices earlier than anticipated.

Even though a factoring company will charge a flat 3% of the invoice face value if the client pays within 30 days, they will slap an additional 1% penalty charge for every additional week the client does not pay.

You will quickly figure out that factoring companies favor businesses with quick-paying customers but punish those with slow-paying ones.

The best deal is one that offers large upfront payments while charging low-interest rates—for instance, 90% advance payment on invoice approval while charging 0.5% interest.

b. Typical fees and costs

Not only should you consider the factoring fees, but you should also keep an eye on the additional costs as those can quickly add up.

As with any other money-lending venture, you have to read the fine print to figure out the actual cost of the facility and find ways to avoid ‘hidden’ fees. These may include:

Due diligence fees: this is probably the first cost you will rack up when the factor needs to verify the creditworthiness of your clients. They will need to ascertain that they have excellent credit scores and no unpaid taxes or existing liens. The due diligence bill can run up to a couple of thousand dollars.
Maintenance fees: the accounts receivable company will charge a monthly maintenance fee to manage your account.
Monthly minimum fees: when entering a contract factoring, the accounts receivable company will require your commitment to maintaining monthly minimums, charging a monthly minimum penalty if you fail.
Origination fee: refers to the application process cost of the factoring arrangement.
Renewal fees: when a contract with a factor ends, some may require you to pay renewal fees if you wish to enter a new factoring agreement.
Money transfer: whenever the factor moves money to your account, they charge you for that factoring transaction.
Termination fees: if you decide to end a long-term contract, the factor will charge a termination fee, often in the region of 3-10% of your factoring credit line.

c. Spot factoring or contract factoring

Before opting for spot or contract factoring, figure out your business needs as your decision will significantly affect how much you pay in factor fees.

If you are trying to sort out a temporary or emergency financial hurdle, spot factoring is your best move. This option allows you to choose the invoices to send the factor, free from the shackles of a contract. However, spot factoring usually carries higher factor fees.

Contract factoring means tying down your invoices to a factoring company for an extended period. You will sign a long-term contract, which is usually at least six months long, requiring you to sell several invoices each month to the factor.

Although the factoring fees will be lower, the contract compels you to send a set monthly minimum volume of invoices. There will be a penalty if you do not meet this target or if you decide to end the contract earlier than expected.

d. Recourse vs. non-recourse factoring

Another feature to consider is recourse or non-recourse, and like spot and contract factoring, will considerably determine your factoring costs.

You would think that since accounts receivable refers to selling an invoice to the factoring company and once you have received payment that is the end of your liability, but that is far from what it means.

Generally, you would still be liable for non-payment of that invoice unless under particular circumstances.

The above scenario highlights what happens in full recourse factoring. If your client is late or does not pay, you will pay the factor’s total fees plus any unrecovered amounts. Since the factor has the added safety of your commitment to pay them if the client fails to, the costs in recourse factoring are lower.

As for non-recourse, the burden of following up on payment rests with the factor as they cannot ask you to pay late or unpaid invoices. Since it is such a risky venture, the factoring fees will be higher than full recourse factoring.

However, this is not an absolute cover, as most non-recourse contracts will have you pay if the customer defaults, unless they go bankrupt or undergo closure.

Whatever your choice, it is in your best interest to ensure you send customers with a good credit history to the accounts receivable factoring company.

e. Eligibility requirements

You want a factor that will not have such strict admissibility requirements since the essential aspect of the agreement is the customer’s credit score.

f. Customer service

Go for an invoice factoring service company with an excellent customer service track record. That entails services such as a local branch, dedicated account manager, phone, email, and live chat options on their website. These options should enable easy contact with your provider whenever you have concerns about the service.

One of the best alternatives to invoice factoring companies is Resolve. They are a complete B2B payments solution that helps business owners, wholesalers, distributors, and manufacturers manage their net terms risk and improve cash flow.

Even though you may have agreed to 30, 60, or 90-day payment terms, Resolve will disburse the agreed amount within a day of invoice approval.

Benefits of accounts receivable factoring companies

The many benefits of accounts receivable factoring are:

Easier to apply for than a conventional loan: although a traditional bank loan offers excellent terms, you need to fill in a ton of paperwork and then watch them drag their feet for ages before the clearance. Invoice factoring is as simple as an online application, often getting approval and disbursement of the cash within two business days.
Quick cash: To stay competitive, industry-wide practices may force you to agree to 30, 60, 90 net term periods before payment. One way around this is using factors to get cash fast. That can help you settle payroll or pay supplies vendors.
No collateral: unlike a bank loan line of credit, you don’t need collateral to qualify for factoring.
Saves time: since you get your money instantly, you won’t spend time chasing after payments, time you can better spend towards developing your business.
Prior financial status does not matter: you need impeccable personal credit scores to qualify for a conventional loan; that’s not the case with invoice factoring. Even if you have a terrible credit history, what matters to a factoring company is if your customers are creditworthy.

Why Resolve has the best solution instead of accounts receivable factoring

If you thought the run-of-the-mill factoring companies are fantastic, wait till you read Resolve’s proposal:

Faster cash flow unlocks: while most factoring companies will process and release the cash 48 hours after invoice approval, Resolve Pay’s same-day funding cuts that down to 24 hours.
Quicker credit checks: the hold up before releasing cash is because of customer credit checks, which Resolve has mastered. Not only do they offer free credit checks, once they approve a customer, Resolve Pay will advance up to 90% of any subsequent invoices until you hit that customer’s credit limit.
Reasonable fees: most factoring companies carry hidden costs and exorbitant factoring rates. Resolve has a fixed one-time fee of 2.61%. What’s more, Resolve only charge you for the amount you borrow for an invoice. For instance, from a $1,000 invoice, you might only borrow $500. Resolve will only charge interest on the $500 you borrowed. Other factoring companies would still charge you on the full $1,000, even though they only advanced $500.
Assumes risk of non-payment: The Company offers non-recourse factoring, which means they assume the credit risk if the customer goes bust or fails to pay.
Transparent charges: apart from displaying the charges on the website, Resolve has a simple flat-fee advance rate of 2.61% for a 30-day net term invoice and 90% advance.
Does all the heavy lifting: Resolve’s accounting software will conduct the customer credit checks, handle net term allocations, process cash payments, follow up on payments, and integrate back office support. That frees up valuable time and resources to get back to growing your business.

To sum up, if you need to get yourself out of a cash crunch, using a more modern solution (i.e. Resolve) to an accounts receivable factoring company is a practical option. What are you waiting for? Request a free demo to find out how Resolve can improve your credit process, risk-free net terms, and cash flow.