Invoice factoring and accounts receivable

Invoice factoring is a way to get a quick cash infusion into a business by selling their accounts receivable to a factoring company. The business sells the account receivable – otherwise known as an outstanding invoice, at a discounted rate to the factoring company but as an immediate cash payment. In return, the business gives up the right to collect payment from invoices that they’ve chosen to sell. The factoring company usually buys the invoice for 80-90% of the total value, and they receive the full payment from the client directly. Companies will sell their invoices to improve cash flow and stability quickly when they can’t afford to wait 30-90 days for payment from the customer.

Businesses who are having cash flow problems might be interested in factoring their invoices to get a fast cash infusion if unexpected costs arise, or if their accounts payable are bigger than accounts receivable. There are two types of factoring: recourse and non-recourse factoring. They're both options for a quick payment, but there are some more differences to understand before deciding which is best for your business.

Recourse factoring is the most common form of invoice factoring agreement. It's premised on the idea that if the factoring company can't receive payment on outstanding invoices, it’s the responsibility of the business to collect payment from the customer and pay the factoring company back. Simply put, the company that sold the invoice is responsible for non-payment by their customer and takes on the risk of non-payment and possible bad debt. Recourse factoring has more flexible credit requirements, meaning that somebody who has a less than stellar credit record can still use recourse factoring. They also offer lower fees and options with advance rates but can require multi-year contracts.

Business negotiation

Non-recourse factoring

Non-recourse factoring is distinguished by one ample difference from recourse factoring—that the factoring company takes on the credit risk from non-payment. If the customer refuses or is unable to pay off the invoice for whatever reason, the burden doesn’t fall on the business. Rather, the factoring company itself will repay it. Non-recourse factoring takes on a much larger risk, so using the service comes with much higher factoring fees and lower advance rates. As a result, a non-recourse factoring company must be much more selective with their clients, citing that anybody with a less than perfect and prompt repayment record will not be approved to use non-recourse factoring. The advanced rate, however, is usually lower than in recourse transactions and there are typically no long-term contract requirements to use non-recourse factoring.

Non-recourse factoring is a good idea for larger businesses with a broader customer base to use if they’re looking to ease up their balance sheet at the end of the quarter or create some working capital. Waiting on outstanding invoice payments come quarter-end can be frustrating. They might use factoring services to sell those accounts receivable, so they get the payment over with and move on to the next quarter without worrying about being liable for a client’s nonpayment.

Disadvantages of non-recourse factoring

Non-recourse factoring is completely free of the risk of being liable for a customer’s non-payment (often including cases of insolvency), but they usually come with a much higher transaction fee. Forking up enough money to pay the transaction fee with a non-recourse factoring company can be very difficult for those with cash flow issues. Keeping in mind, cash flow issues are usually what encourage businesses to factor their accounts payable in the first place. In the event of working with a non-recourse factoring agreement, the business owner should evaluate their customer profiles and decide whether it’s worth a larger factoring rates, or if they can handle the risk that recourse factoring entails.

Essentially, each company will have to weigh the pros and cons of using either recourse factoring, or non-recourse factoring, depending on their revenue, client base, and cash advance needs. Their income and the amount of cash needed will determine how many invoices they'll need to factor. They will also need to weigh whether they have the money to afford non-recourse factoring or if they're comfortable assuming the risk of recourse factoring.

The pros and cons of each type of recourse factoring depend on the individual business and their needs. Generally, the cons of using non-recourse factoring are the additional transaction fee cost, higher factoring fees, stricter credit requirements, and monthly minimum fee requirements. This means that the factoring company requires that the business must provide the company with a particular volume of transactions per month. This could be an issue for a company whose clients don’t have an excellent credit history and don’t qualify for non-recourse factoring. This puts businesses who need a quick cash infusion in a tricky spot because their cash infusions are then limited.

Factoring company

Factoring companies buy a business's unpaid invoices at a discount and collect payment from the client in full. Once the factoring company pays for the invoice, they collect ownership of the outstanding invoice, the responsibility falls on the client to repay the factoring company directly. Factoring companies work to help businesses reduce the losses that occur with non-payment. Factoring companies protect a business's assets, analyze new clients' credit history, and float them the money they need if cash flow slows down.

Some of the most common resources for business financing in the form of factoring include altline, ecapital, day funding services, and triumph business capital. Although many small businesses lose about 1.15% to 3.5% per month in revenue in fees to the factoring company, using them to restore cash flow may be worth it for most companies. Factoring companies move faster than banks or other money lenders because they make more money when the businesses they work with don’t lose money over non-repayment. For this reason, a factored invoice can offer solutions to cash flow issues and are an alternative to business credit cards, a business line of credit, or a business loan from a traditional lender.

Trucking companies and freight factoring

Trucking companies, shippers, and freight brokers face substantial expenses that they need to pay for before they take any of that money home. Paying for fuel cards, insurance, regular maintenance, staffing, and unexpected repairs can use up a lot of their anticipated revenue. For most mid-sized trucking companies, these unavoidable expenses outweigh their income. Some customers may not pay for a service upfront every time a delivery is done, and delayed payments can cause some serious cash flow issues if they happen consistently.

With recourse factoring through an invoice factoring company or freight factoring companies, trucking companies can factor their accounts receivable and seal up the financial gaps with a quick cash infusion to keep them on their feet. Recourse factoring will get them over the hump of paying what they owe suppliers and making sure their employees get paid too without getting a loan or accruing debt. All of this will help trucking companies spend less time chasing unpaid invoices.

Because of the higher fees and credit score requirements, trucking companies may not find non-recourse factoring to be worth it for their business. They may feel more inclined to use recourse factoring and take on the risk of liability themselves while saving money on additional fees.

How factoring works

How factoring works

This is how businesses can approach factoring options. First, they need to decide between a recourse and a non-recourse factoring company, based on what is more fitting for the requirement of their business and clientele. They will then set up an account with their preferred factoring company and pick which clients they want to factor. The factoring company will run a credit check on each of these clients to check for creditworthiness and credit risk.

Companies then send outstanding accounts receivable of the clients they’ve chosen (and have been approved) to factor to the factoring company and receive cash in return—usually totaling 80% to 90% of the total amount owing on the invoice. The client that is being factored will be informed, so they can easily pay the amount that's owing to the factoring company directly. The factoring process is quick and effective because it moves faster than other lending services – barring any complications that arise through credit or client issues.

One of the concerns related to factoring revolves around the credit checks that are run on each client by the factoring company. These are full checks and may take time to complete. Once a client is approved, the factoring (and payout) process is prompt. But it shouldn’t be a last-minute solution if the client for the invoice you want to factor isn’t yet approved.

Another concern is the impact of having a third party agency collecting on an outstanding invoice. Factoring can suggest to your customers that you’re having cash flow problems. While this is most likely the case, it may not be in your best interests for your customers to know.

And finally, not all factoring companies operate in the same way. Some are incredibly aggressive when it comes to collections. This, too, may impact your relationship and reputation with your customer. Before choosing a factoring company to work with, check out their reviews, and go to the BBB (Better Business Bureau) to see if any complaints have been filed against them.

There is an alternative to factoring called digital-terms-as-a-service. Companies that offer this service align with fintech solutions rather than just financing/factoring. One such company is Resolve. They’re able to run discrete, or ‘quiet’ credit checks on a business that won’t impact their credit rating.

Using the information from this check, Resolve advises businesses on how much credit to extend to each customer, and what net terms to offer. The business then works directly with the customer and always holds the invoice under their branding and payment platform (which Resolve offers as part of their service).

Clients have 30, 60, or 90 days to pay their invoice, but Resolve pays the company up to 90% of each invoice within one day. This creates an immediate cash flow solution without impacting the client or customer relationship in any way.

Rest assured that cash flow and invoice collecting challenges are common with almost all small and mid-sized businesses (SMBs) these days. Finding the right solution for your business means having the resources you need to keep and grow your business.