Accounts Receivable Factoring: What is Factoring Receivables?

For example, say a factoring company charges 2% of the value of an invoice per month. Get started today and let FactoringClub help you find the perfect factoring company for your business. Our expert team is committed to connecting you with the most suitable factoring partners, saving you from the time and hassle of choosing the right factoring company. Factoring is often a bridge to more traditional forms of financing such as accounts receivable financing. First, you need to operate a B2B (business-to-business) enterprise, as factoring is designed for trade credit transactions between businesses.

If the invoice is never paid and you’ve agreed to recourse factoring, the invoice will be sold back to your business. Factoring fees typically consist of a discount rate and various administrative fees. The discount rate is the percentage deducted from the total value of the factored invoices.

Invoice Factoring vs Bank Loans

It’s a transparent process so your customers make payments to the correct entity, protecting you, the factoring company, and your clients. Invoice factoring companies charge a factoring fee or rate when purchasing your invoices. The average cost of invoice factoring is 1% to 5% of the total invoice value. For example, if your total invoice value is $10,000 and the invoice factoring fee is 5%, it will cost you $500 to factor your invoices.

Interest rates

If your business has high profit margins and can afford to wait for customer payments, you may not need to look at options such as invoice factoring. Seasonal businesses with fluctuations in cash flow, such as holiday-related manufacturers or wholesale manufacturers, may need additional cash to cover operating expenses during off-seasons. Accounts receivable factoring can be a reliable source of funding to bridge the gap between slow and busy times of the year. After receiving payment in full, the factoring company clears the remaining balance, typically 1 – 3%, to the selling company.

However, non-recourse factoring means that the factoring company accepts those potential losses. Non-recourse factoring generally comes with higher costs because the factoring company assumes more risk. The factoring agreement will specify who bears the risk of loss if a customer can’t pay an invoice. Recourse factoring, the more common and cost-effective of the two, places the burden of non-payment on the business. If an invoice isn’t paid within a pre-determined timeframe, the factoring company retains the right to sell the invoice back to you. It’s essential to understand that the assignment of invoices is not a practice of selling your customers’ information or trust.

Accounts receivable factoring vs accounts receivable financing

The factoring company will take a cut — called their factoring fee — before paying you the rest of what you’re owed. The factoring fee will be charged at regular intervals until your clients pay their invoices. Rates may be calculated based on the face value of the invoice or the amount of the cash advance. Accounts receivable factoring is a financial arrangement where a company sells its accounts receivable to a third party, known as a factoring company (or factor), at a discount. This allows the company to access immediate cash, rather than waiting for customers to pay their invoices. It is a common practice in industries where lengthy payment terms are standard and cash flow management is critical.

The concept of “receivable factoring” has been going on in the United States retirement of bonds since the 1600s, when various colonists sought individuals to advance payments on raw materials that were being shipped to England. Business lines—or operating lines—of credit are another commonly used form of post-receivable financing. This just means it’s financing after an invoice has been generated (purchase order financing is the inverse; it’s a form of pre-receivable financing).

Borrowers will receive financing based on what their accounts receivable is worth. Then, once the invoices are paid—the collections process in this scenario resides with the seller—the borrower pays the lender back, with fees. Once the factoring company approves the invoices, the company receives the upfront payment, which can be a significant portion of the total value. This immediate injection of cash can be used to cover operational expenses, invest in growth opportunities, or pay off existing debts.

Administrative fees can include servicing fees, due diligence fees, and other charges. It is important for companies to carefully review and compare the fees offered by different factoring companies to ensure they align with their financial goals. When a company engages in factoring, the factoring company evaluates and monitors the company’s customers’ credit. This reduces the company’s exposure to late payments, defaults, and bad debts. Understanding the step-by-step process of accounts receivable factoring helps you grasp how it can provide immediate cash flow by converting your outstanding invoices into working capital. Now, let’s move on to the next section and explore how to calculate accounts receivable factoring.

To qualify for accounts receivable factoring with FundThrough, start by creating a free account or connecting your existing QuickBooks or OpenInvoice account. Your business should have at least $100K in outstanding receivables to one customer, invoice other businesses (B2B) or government agencies for completed work, and not operate within construction or real estate. Required documents include business formation proof, a government-issued photo ID, and a void check from your business account.

What are some factoring receivables companies?

And because receivables factoring isn’t technically a small-business loan, it can be a good option for business owners with uneven or short credit histories who may not qualify with a traditional lender. The factoring company buys the invoices and pays the business a percentage of each invoice. The factoring company then assumes the responsibility of collecting the unpaid invoices. If your business offers customer financing by invoicing clients for services or products, you might be able to factor in invoices. When a business sells its unpaid invoices to a factoring company, it receives an upfront payment, usually a percentage of the total invoice value. The factoring company then collects the full payment from the customers, deducts a small fee for its services, and provides the remaining balance to the business.

1. The company agrees to buy your accounts receivable for the value of the invoices minus a factoring fee of 4%.
2. When a company engages in factoring, the factoring company evaluates and monitors the company’s customers’ credit.
3. Then the factoring company collects money from the customer over the next 30 to 90 days.
4. It’s essential to understand that the assignment of invoices is not a practice of selling your customers’ information or trust.
5. In some manufacturing industries and the textile industry, factoring is one of the financing vehicles of choice.
6. Let’s assume you are Company A, which sends an invoice of $10,000 to a customer that is due in six months.

It outlines the specific terms and conditions under which the factoring transactions will be conducted, and it is vital, therefore, that you understand all its components thoroughly. The cost of accounts receivable factoring with FundThrough is clear and upfront, involving a single fee. For detailed information on our pricing structure, we recommend that you to visit our pricing page.

Aside from the advantage of getting cash upfront, accounts receivable factoring is also commonly employed as a strategy to transfer payment risk to another party (in this case, the factoring company). Second your customers should have a strong credit history, as the factoring company relies on their financial stability to ensure payment. The difference is that, instead of selling invoices, you’ll have to repay your lender or invoice financing company the amount you borrow. Thus, the invoice factoring service will pay you a total of $24,000 ($25,000 x 96%) for the invoices.

Many factoring companies will offer an advance rate of 75-90% of an invoice’s face value. This higher advance rate is considered attractive by many borrowers and might justify the higher cost. You will typically find accounts receivable factoring through specialized companies, like FundThrough or AltLINE. Factoring companies may also specialize in certain geographies or industries, like construction or trucking.

Recourse factoring tends to be the most common and requires your company to pay the factoring company for any invoices that it’s unable to collect payment on. With nonrecourse factoring, the factoring company assumes the risk and you do not have to pay them back for any amount they do not collect. Factoring companies turn a profit on your unpaid invoices by charging you a factoring fee—usually between 1% and 5% of the total invoice value. The exact fee will depend on the amount xero accounting software of the invoices and the creditworthiness of your customers. Accounts receivable factoring doesn’t require collateral or impact a business’s credit rating.