Accounts receivable factoring also referred to as invoice factoring or AR invoice factoring, can be the optimal business funding solution for any business looking for instant funds to pursue its strategic goals or day to day activities. In a fast-paced world, growing is the key factor of success for businesses. Regardless of its life cycle stage, growth is a driving imperative for any company to reach its full potential. To grow, the business needs to invest and often will require funds that it doesn’t necessarily have at the poignant time. In that case, the company would have to seek external funding solutions. Traditionally, a bank loan was the best option for business owners seeking assistance. However, depending on circumstances and increasing restriction and regulation in the lending market, it is not always granted and is often time-consuming.
What is Accounts Receivable Factoring?
Accounts receivable factoring is a type of debtor finance inducing a financial transaction in which a business sells its accounts receivable to a factor at a discount. The factor will offer an upfront payment to the business based on amounts due from its customers. On due dates, the factoring company collects the debt from the end customers and returns the remaining balance to the business client after subtracting the already paid amount and service fees. Invoice factoring empowers businesses to retain a steady cash flow and uplift working capital to support growth.
For example, Hosts Staffing Agency requires funds for its immediate needs. The agency contacts AR Funding (AR) to sell $70,000 of credit-worthy. AR advances them 90% or $63,000. According to the original terms of the invoices, AR will collect the debts on their client’s payment and return the 10% money to Hosts Staffing Agency minus the 1-2.5% factoring fee.
How is Accounts Receivable Factoring Different from a Bank Loan?
At any point in time, a business can find itself in need of additional funding either to grow or to manage its daily operations. Sometimes, the business is strong enough to be eligible for a bank loan but, often, they can’t obtain the working capital they need. Thus, a less traditional financing method such as invoice factoring is imperative. In both cases, a company must prove its eligibility to secure the funds by meeting specific requirements. The difference between invoice factoring and a bank loan relies on this process. These requirements can be summed up in the concept of the 5 C’S (Character, Credit score, Capacity, Capital, Collateral). When analyzing these requirements, a factoring business would focus on turning the business client’s account receivable into capital by considering the credit score of the business’ customers, shifting the credit risk from the business owner to AR, looking to the business gross margin instead of the annual revenue and by treating invoices as collateral. Versus a bank, who would only grant a loan after checking the business client’s credit score, monthly and annual revenue, actual capital and treat the business assets as collateral.
For example, if Hosts Staffing Agency were to be granted a loan, the business is required to prove its ability to pay back the loan by providing an experience and industry track record, a strong credit score, a valuable annual revenue and considerable assets such as real estate. If the agency were to obtain funds through invoice factoring, they would go through AR verification, meaning that if the account debtors are satisfied with the provided service or product characteristics and that the invoice amounts, terms and conditions are in order, the agency would be granted the needed funds.
Therefore, if a business possesses credit-worthy invoices and is willing to factor them, funding is available. This way, it would speed up its cash flow by taking advantage of already owned assets in a lapse of time in as little as 24 hours, whereas going for a loan would not only create a debt on the business balance sheet that it is expected to be paid back over a specific period, along with a high amount of interests in most cases but is also time-consuming as it can take weeks or even months.
Why use Accounts Receivable Factoring Services?
As explained before, invoice factoring provides businesses with a financial solution to obtain funds based on due amounts from their customers. The factor helps them manage their cash flow by offering an upfront payment for their account receivable. The factor (i.e. AR Funding) can offer to fund up 80-90% of the business client credit-worthy AR depending on the industry. However, the business has the right and the absolute freedom to decide the number of invoices it wishes to factor and the invoices they would like to keep. Invoice factoring helps the business not only improve its cash flow, handle the day-to-day activities and invest in its growth sooner but also provides an alternative option when difficulties occur to obtain other means of funding. It keeps the business cash flow fluid and improves efficiency as the business will access its owed money while still allowing its customers the same time to pay their invoices. In fact, factoring can also be seen to provide industry solutions. For example, the business can exercise faster inventory turnover when receiving an expedited payment of its invoices ameliorating efficiency and profit.
Factoring businesses provide funding for companies of all sizes and stages and offer valuable options including credit protection, credit analysis, smart funding and collections services. It can play a fundamental part in a business funding mix, either as an alternative or complement to traditional funding options. Thus, whatever business you are running, no matter if you are a start-up or a long-established company, if you hold credit-worthy invoices, factoring is the most optimal option for a debt-free, cost-effective, quick proceeding solution to combat cash flow crunches. Bank loans are not your only resort, do not limit your options.