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.
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.
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:
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.
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.
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.
These are the types of situations that a business would most likely find themselves resorting to 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:
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:
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 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.
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:
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.
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.
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.
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.
The many benefits of accounts receivable factoring are:
If you thought the run-of-the-mill factoring companies are fantastic, wait till you read Resolve’s proposal:
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.