Growing your business / Resources

Can Factoring Accounts Receivable Help Your Business Grow?

By: Kate Samano March 1, 2022

There are occasions when small businesses get in a pinch with cash flow through no fault of their own. Long payments terms are common when it comes to accounts receivable, but it can still catch you off-guard. If your organization is waiting on a payment but needs cash immediately, factoring accounts receivable could be the perfect solution.

Debt factoring is cheaper, faster and easier to get approved for than a bank loan, but it also comes with some disadvantages. Continue reading to find out more about how invoice factoring works and whether it could be a viable solution for your company.

What Is Invoice Factoring?

Invoice factoring offers a quick solution to cash flow problems for businesses that are able to sell off unpaid invoices to a factoring company. A lump sum, between 75% and 90%, is usually paid out within a few days, and the fees associated with this method of funding are often lower than those with traditional loans. The remaining balance minus fees is paid out to you once customers pay their invoices in full. 

Disbursements usually total 10-20% of the full invoice amount. The trade-off is freeing up cash flow instantly in return for a percentage of your unpaid invoices. It’s not a loan in the traditional sense because you’re selling a product instead of borrowing money against existing collateral. You don’t need to produce as much paperwork as you would for a loan, and it’s often a better option for small businesses and startups that haven’t yet built a solid credit rating

Another major difference between factoring accounts receivable and a loan is the speed of payments. You might have to wait months to get a loan, which isn’t feasible if your cash flow issues require immediate attention. What’s more, with invoice factoring, repayments aren’t set at a fixed monthly percentage.

Some of the ways companies might leverage debt factoring include:

  • Payroll
  • Advertising and marketing
  • Paying recurring bills, such as rent and utilities
  • Investing in equipment
  • Collecting funds from invoices faster

How Invoice Factoring Works

Every company has a slightly different process when it comes to factoring accounts receivable. Let’s take a look at what you might expect to go through when securing this method of small business funding:

  1. Invoices are the product you sell to factoring companies. Every time you raise one with a customer and they agree to pay it, you have something you can offer in return for instant cash. Factoring is usually available for invoices with payment terms between 30 and 90 days.
  2. Choose a factoring company to sell your invoices to. There’s a lot to consider when picking the right company, such as the frequency and amount of invoices you want to sell, the length of time a payout might take, the reputation of the company and more. You’ll find more information on how to choose a debt factoring company later on in the article. 
  3. Now you’ve found a company that suits your requirements, they need to decide if working with you is worth the risk. As soon as you’re approved and you sign the factoring agreement, the process begins. Always read terms and conditions carefully, and work with a financial expert to get the best deal. 
  4. You’ll quickly receive an advance from the factoring company, which is often 75% and 90% of your total invoice value. With a disclosed agreement, the factoring company might send out a notice to let your customers know they’ve taken over accounts receivable. This gives them all the information they need to send future payments to the correct recipient.
  5. Once invoices are paid to the factoring company, they send you the remaining balance minus its rebate. 

Debt Factoring Eligibility

It’s easier for many companies to apply for invoice factoring than a traditional loan. Many factors don’t require a credit check, and fewer documents are required to get approved. The main thing the lender wants to see in this instance is the reliability of your customers.

Of course, they want to make sure they get their money back plus fees, so there are some expectations with regards to your company. You may be required to produce:

  • A profit and loss statement to prove you’re a viable business
  • Contracts and documents regarding your invoices
  • Recent bank statements or business credit card statements  

The company is also likely to want to see evidence that your customers are going to pay them. For evidence of this, they might request:

  • Copies of all unpaid and partially paid invoices
  • Balances and contact information for all customers

Before putting in an application for factoring accounts receivable, you should think carefully about how reliable your customers are. Late payments could result in you being liable for hefty fees. Consider the following about your clients:

  • Do they usually pay on time?
  • Do they have a good credit history?
  • What industry are they in?
  • Do they have an established reputation?
  • Do they have legal or debt issues? 

Pros of Factoring Accounts Receivable

Poor cash flow is the downfall of many businesses, and freeing up capital can be a lifeline when you’re in a stitch. When done properly, invoice factoring can be a huge benefit to small and medium businesses (SMBs) for the following reasons.

Improved Cash Flow and Forecasting

Invoice factoring allows you to gain access to funds as soon as an invoice is raised. Instead of waiting one to three months for payments, the factoring company gives you the majority of the balance immediately. This allows you to make accurate forecasts and act quickly in case you need to reinvest.

Free Up Time for the Finance Department

Chasing customers for payments isn’t just time-consuming, it can also be stressful. By taking this task off your finance person or department, you free up their time, which could be better spent planning for the future or coordinating income and expenditure. 

Reduces Overheads

Dedicated credit control staff could be much more costly than an invoice factoring agreement. What’s more, you can free up money to pay expenses, such as rent and utilities, on time, every time, reducing the risk of late payment fees or stacked debts. 

Simple and Fast

Some of the most attractive aspects of factoring accounts receivable are the speed and simplicity compared to traditional loans. Approval for the latter can take weeks or months, whereas debt factoring is likely to secure funds within a week. You don’t necessarily need a glowing credit rating, and fees are often lower than what you might expect to pay for a bank loan.

Cons of Factoring Accounts Receivable

If you don’t have a solid customer base, you might not get approval for invoice factoring. Factoring companies want to make sure the means are available for them to get their money back and prefer to spread risk rather than hedge their bets on a few clients. Below are some other drawbacks of debt factoring. 

Often a Long-Term Commitment

Many factoring companies expect a long-term contract that involves taking over most of your accounts receivable. Spot factoring is an exception to this, and we’ll discuss it in more detail later on. For the most part, you’ll need to sign a contract for a year or more, making it a serious decision for your company. 

Beware of Fees

While disbursements are usually low, the cost can quickly stack up if the factor perceives you or your clients as high risk. What’s more, if your clients don’t pay as promptly as the factoring company expects, they might hit you with some major factoring fees. 

Waiving Customer Experience

When you factor accounts receivable, you’re handing over the responsibility of part of your customer experience to a third party. While this can take strain off your company, it could also harm your reputation. 

No Impact on Credit Rating

A good credit score is crucial for most businesses to survive, and this type of alternative funding doesn’t help with your credit score. It’s a great option for freeing up cash immediately, but you should be aware that it doesn’t carry all the same benefits as a traditional loan agreement. 

Fees

The discount rate or factor rate is the transaction fee charged by a factoring company, usually between 10% and 20% of the total invoices. In general terms, the more invoices you have, the lower the rate. The factoring period also plays a key role in how much you’re charged in fees, with longer factoring periods costing more. You might also find the following fees mentioned in your agreement:

  • Origination fees
  • Service fees
  • Incremental fees
  • Renewal fees
  • Unused line fees
  • Collection fees
  • Monthly minimum fees
  • Non-recourse factoring fees

What to Look for in a Factoring Company

Choosing the right factoring company can be tricky with so many of them out there. Some charge lots of hidden fees, and others might not be as reputable. It’s important to choose the right one. Otherwise, you could do serious damage to your business and reputation.

Let’s look at important factors to take into consideration when choosing a factoring company.   

Disbursements and Payment Terms

Reading the small print is crucial when it comes to any contract, but particularly with regards to finance. Choosing the wrong company could result in extortionate fees and unreasonable payment terms. That’s why we recommend working with a partner like Lendzi, which vets each factoring company and recommends the most suitable one for your budget and requirements.

Non Recourse vs. Recourse Factoring

Recourse factoring is the most common method of factoring accounts receivable. With this type of agreement, the company can recover unpaid invoices from your business if clients pay late. Depending on how long they take to pay, fees can stack up quickly. Nonrecourse factoring means the company won’t punish you if customers don’t pay on time, but you usually pay a fee for this service.

Confidential vs. Disclosed Factoring

Disclosed factoring is more common and involves the factoring company directly asking your clients for payments. With confidential factoring, your clients are none the wiser that a company is requesting payments on your behalf.

Contract Factoring vs. Spot Factoring

Contract factoring is often a long-term agreement with a factoring company, which means you’ll sell the majority of your accounts receivable for upwards of a year. If you have some customers who are renowned for late payments but have many that do pay on time, spot financing might be more sensible. With this type of agreement, you can pick and choose which invoices you sell.

Industries Frequently Using Factoring Accounts Receivable

Invoice factoring can benefit any company, but it’s most frequently used in the following industries:

  • Printing
  • Construction
  • Trade services
  • Professional services
  • Recruitment
  • Manufacturing
  • Logistics
  • Retail
  • Wholesale

Should Your Company Use Invoice Factoring?

Factoring accounts payable isn’t the best option for everyone. If you don’t have a lot of customers or you can’t rely on your clients to make timely payments, this probably isn’t the best financing option for you.

If you regularly have a stack of outstanding invoices, it’s affecting cash flow and you have a large roster of reliable customers, it could be the ideal funding option for your small business. 

Find the Best Debt Factoring Lender Today

Let Lendzi take care of the hard work of finding a reliable, responsible factoring company, so you can spend your time focusing on boosting your bottom line. 

Ready to get started?

How much money do you need?