The Basics of Factoring Receivables

We have seen many business owners and advisors overlook factoring receivables as a viable option for financing and managing cash flow. While it is not the best option for every company in every situation; companies with factorable accounts receivable should consider its use.

You may be wondering: how do I know if factoring receivables is something to consider for my company? There are a few criteria you should use to evaluate your business model before considering factoring as a possibility.

  1. Do you have a high value and low volume of receivables?
  2. Are your terms longer than 30 days with most customers, or do you have a slow/insufficient turn-over period?

If your business meets one of these criteria, you would be a candidate for factoring receivables.

What is Factoring?

So what is factoring receivables? Factoring is simply selling your accounts receivables to a funding company at a discount. The factoring company will typically advance you between 50% and 80% of the face value of your invoices based on your agreement. This amount is determined by the credit and reliability of both you and your customers. The better your record, the better rate a factoring company is willing to give you. When the money is collected, the factoring company will send you the remainder of the invoice minus any fees.

Benefits of Factoring

There are some definite advantages to factoring your invoices, the biggest one being the availability of cash. While a large accounts receivable balance may mean your company is profitable, it isn’t useful for funding day to day operations if your customers don’t pay for 60 days. Factoring allows you to get the money up front and use it to finance your business. However, you should also know about the potential risks as you consider this alternative for financing.

Down-sides to consider

  1. There are always fees. Factoring companies charge a fee based on the invoice amount and the days the invoice is outstanding. The longer it takes to collect, the higher the fee. When customers default on accounts, these fees can add up quickly.
  2. The factoring company is not a collection agency. While they collect your accounts receivable for you, they do not pursue collections from your customers. If someone defaults on an invoice that you factored, they will come to collect from you the amount that was advanced plus any fees.
  3.  It is very easy to get caught in a factoring agreement. Cash flow in a business is very cyclical. When you use factoring to fund your business, your cycle is based on collecting cash when you invoice. It makes it very hard to get out of because you have to have the ability to completely fund your business for two cash cycles without collecting from any customer.

These are important items to consider before you decide to use factoring to fund your business.

The decision to use factoring is critical for a business. Before making that final decision, be sure to seek counsel from your business advisors, like TGG Accounting, to help you understand the opportunities and risks for your business.

Written by:
Ashley Peth
TGG Accounting
 
 
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