What Merchants Need to Know About Accounts Receivable Factoring

Do you need more cash flow in your business? Then you might have considered working with an accounts receivable (A/R) factoring company. It's one of several options that companies use to gain short-term cash flow and keep their business sustainable.

Before you dive in to this financing model, it’s critical that you understand exactly how it works, what benefits it provides, and the disadvantages you may face. Continue reading if you’d like to learn these things and more about A/R factoring.

What is accounts receivable factoring?

A/R factoring is also known as factoring or invoice factoring. It is a process in which a business will sell its accounts receivables to a company that buys them at a discount.

Factoring allows businesses to receive money faster, improving cash flow instead of waiting for credit terms. You’ll learn about the benefits of factoring in depth later in this article.

Continuing, this transaction can be performed with or without recourse, with the difference being:

  • With recourse

    : The factoring company collecting the receivables can request the business that sold the invoice to provide money in the case the receivables aren’t retrievable.

  • Without recourse

    : Oppositely, selling accounts receivables without recourse means that the factoring company is on the hook in the case of the invoice not being paid.

Remember the invoices purchased by factoring companies are done at a discount. This means that you won’t be receiving the full amount you’re owed for the original services.

A/R factoring is the most common for industries that require a consistent cash flow, such as staffing, e-commerce, or textiles. However, this financing strategy applies to any company that meets the requirements.

How are accounts receivables priced?

There are many different factors that go into how accounts receivables are priced of which you need to be aware before considering it as financing option. These include:

  • Your industry

    : Certain industries will be more or less expensive, depending on the risk that the factoring company will need to take on.

  • Volume

    : The dollar amount of invoices you need factored will affect the price you pay.

  • Credit

    : Pricing can be affected by the quality of credit your customers have.

Whether you opt for recourse or non-recourse factoring will also change the rate you pay. Typically, factoring companies will charge less for recourse financing, as they are not bearing as much risk compared to non-recourse.

Furthermore, the average rates are between 0.05-5% of the invoice amount every month. It’s a general rule that the more invoices you are selling, the lower fee you can expect to pay. Although, the longer you plan to work with an A/R company, the more you will pay in the long term.

Pros of accounts receivable factoring

Now that you understand what A/R factoring is and how it’s priced, let’s take a look at some of the benefits of taking this financial route.

More upfront cash to use

One of the main reasons that businesses use A/R factoring is because they wish to receive immediate cash flow. Waiting 30, 60, or 90 days for an invoice to be paid can leave bills unpaid and progress lacking.

This upfront cash can be used for marketing, acquiring new customers, hiring employees, or purchasing new equipment. It keeps you running your business without any further interruptions.

It’s an opportunity to build credit

Are you a newer company? Then it’s important that you build a consistent credit history for further financing options in the future. Presuming you maintain a good record of repaying, some factoring companies will send this information to credit agencies. In fact, payment history makes up 30% of your credit score.

Business credit is also an underrated tool in the success of a company. It’s been found that entrepreneurs who understand their credit are more likely to be approved for lending and find the process smooth.

Moreover, these business owners expand their companies more often and are less likely to use personal savings for cash flow.

Less time and energy spent collecting from customers

Invoicing can be a back-and-forth process, taking up precious time for both parties. In the case of delayed or non-payment, this process only becomes worse.

That’s where factoring comes into play, as the invoicing and customer interaction is completely outsourced to the factoring company. It will take care of collecting payment, which is now its responsibility. This saves merchants time that they can put back into operating their businesses.

No collateral is required compared to traditional loans

Traditional business loans from banks and other financial institutions will often require collateral to offset the risk. There is no collateral required with A/R factoring, which reduces the risk on your end as a result.

Additionally, loans from banks only have a 23% approval rate versus the 60.7% from alternative lenders. This means that merchants may be better off seeking financing from companies like Resolve. While we aren’t a traditional lender, we do help businesses keep afloat by supplementing cash flow during A/R net-term periods.

Cons of accounts receivable factoring

While factoring has heaps of benefits for businesses, these are some drawbacks of which you need to be aware before working with a factoring company.

Can be costly when compared to services like Resolve

Factoring companies purchase invoices at a discount, which means that you are losing money from the beginning. This is a one lump sum per invoice or based on many invoices are being outsourced.

Even if the amount you pay per invoice is low, it is not uncommon for there to be hidden or extra fees you will need to pay. Businesses interested in A/R factoring will have to perform extra due diligence to ensure that they will not be hit with extra costs because of this.

You sacrifice control

Factoring companies can deny you from working with certain customers based on their credit history and other factors. This then limits your business, and potentially wastes great opportunities.

Similarly, some customers may not enjoy dealing with a third-party company on your behalf. You sacrifice a good deal of control when working with A/R financing companies because of this.

It can negatively impact your reputation  

When you choose to sell invoices to a factoring company, it is then acting on your behalf when collecting payment. In the case that it does not treat customers in a way that aligns with your brand, it can have a negative impact on your image.

It’s also been found that half of Americans have searched for a business on Google before working with them; 45% claimed that they discovered something which made them ultimately not do business with the company. This is why companies need to consider all of the ways their brand can be affected, including through A/R factoring.

Final thoughts

A/R financing is a great option for companies that wish to increase cash flow and continue pursuing new market opportunities.

It will provide you with more upfront cash, while building credit, saving time, and not needing to put up any collateral. However, the downsides include that you will sacrifice control, risk negatively impacting your brand’s reputation, and the costs can really add up.

That’s why you should contact us at Resolve to learn more about how our financing solution will help you achieve everything factoring does, with less downside.

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