Accounts Receivable Financing: Frequently Asked Questions
Traditional commercial loans can be tied to restrictions that can render them inappropriate to certain business’s requirements.
Accounts receivable financing involves a business selling its receivables to a third-party financial company, also known as a factor. The factor collects payment of those invoices from the business's customers, and the business receives an amount equal to a reduced value of the receivables pledged in advance.
Here are the answers to a few of the most common questions about this alternative to traditional commercial loans and financing solutions.
What are the advantages of factoring?
There are many reasons why factoring is a beneficial financial arrangement for certain types of business, the most cited advantage being the immediate boost it provides to the business’ cash flow.
Companies typically choose to factor because it enables them to access cash quickly, rather than wait the 30, 60, or 90-day grace period many clients choose to pay their bills. A healthy cash flow is crucially important to most, if not all, small and medium-sized businesses.
As such, this form of asset-based financing provides companies instant access to working capital without the delays typically associated with business loans. In fact, many factoring companies are organized to purchase and provide cash for accounts receivables within 24 hours. With this approach to financing, businesses needn't concern themselves with repayment schedules or interest payments.
Better, factoring frees up capital that is caught up in unpaid debts, sparing your business the often-uncomfortable ordeal of collecting overdue bills.
To this end, and because of their exposure should too many of your clients be prone to neglecting their bills, a finance company may conduct their own investigations into your customers credit ratings and payment histories.
On top of being a unique financing option, factoring companies can also provide minor accounting-centered services; namely running credit checks on new clients and generating financial reports.
What are the key differences between A. R. financing and a commercial loan?
Accounts receivable factoring has very few restrictions precisely because it isn't a loan. Instead, the money advanced to you is directly tied to your accounts receivable.
Here are some of the key differences between these two financing options:
- Unlike conventional loans, with accounts receivable financing there is no limit to the amount of financing you can pursue.
- With account-receivable financing your business is provided with a line of credit based on sales, not your business's net worth.
- Account-receivable financing doesn't appear on your balance sheet as debt.
- Factoring is based on the quality of your customers’ credit, and isn't influenced by your business history or credit.
- With factoring you are able to save time and effort that would otherwise be spent on collecting money from customers, leaving you with one less thing to concern yourself with.
- Rather than having to sell equity in your business, factoring enables you access to capital without surrendering any part of your business to outside interests.
How do factoring companies determine the value of accounts receivable?
While factoring companies take several elements into consideration when evaluating the worth of a business's account-receivables, the basic rule of thumb is that the easier it is to collect, the more valuable the asset.
Following this logic, a newer invoice will be more valuable than an older, still unpaid invoice, and the larger and more established the company, the more valuable their account receivables will be.
For example, it's a fair bet to assume that a major corporation like, say, Google, is in no danger of defaulting or going under anytime in the near future. As such, you could say that a $2,000 account-receivable from them is as good as money in the bank, which it literally is once it's been purchased by a factor.
At the same time, a $2,000 outstanding invoice that's been owed by the local DVD rental outlet for over six months is a notably riskier investment, hence it's being valued considerably lower than Google's debt.
As a general rule with any business, the more information you can discreetly accrue with respect to your customer base, the easier it will be for you to enter a factoring agreement with your finance company.
What documentation is required to begin the factoring process?
While some minor requirements may change from lender to lender, the principal documentation you'll need in order to get the factoring process started are:
- A completed application
- An accounts receivable aging report
- Articles of Incorporation
- A list of customers and the invoices to be factored
Is there a standard accounts receivable financing rate?
Although it varies slightly by industry and volume, for most enterprises (outside of the transportation sector) factoring advances are in the 75%-95% range.
Are companies obliged to factor all of their invoices?
Typically, no. Some arrangements can be made to exclude a few customers and invoices from factoring. Nevertheless, this must be discussed prior financing with your factor.
What kinds of businesses are most suited for accounts receivable financing?
While factoring is a common business practice across a wide variety of industries, it tends to carry a particularly large presence in the transportation, trucking, textiles, manufacturing, and wholesale and distribution sectors.
Invoice factoring is both a funding and business solution, but the primary reason why companies choose to factor is the quick access to cash it provides.
Our commercial funding experts can help you build a financing program that fits your needs. Contact us to find out if A. R. factoring is right for your business.