What You’ll Learn:
- Pros and cons of factoring accounts receivable
- Why Hopscotch Flow is an excellent alternative for cash flow management
Accounts receivable factoring allows small businesses to gain quick access to cash. The invoice factoring process is relatively simple: A business sells its invoices to a factoring company, which fronts a percentage of the invoice in exchange for a service fee. When the invoice is paid, the factoring company forwards the rest of the payment (minus their fee).
Here’s what you should know about how factoring accounts receivable can benefit small businesses.
Improved cash flow
Why would a business factor its accounts receivable? It improves cash flow. Converting receivables into cash provides more liquidity, which gives your business more control over money, including how and when to spend it.
In particular, small businesses with limited savings reserves or slower income streams can benefit from factoring. With this financial flexibility, a company can cover operational costs, pay suppliers on time, and even invest in growth—all on their timetable.
Loan-free access to funding
Some companies turn to accounts receivable financing (AR financing) rather than AR factoring for quick cash access. Under this model, businesses qualify for loans based on their creditworthiness, with invoices acting as collateral.
Unlike AR financing, invoice factoring is not a loan. It offers businesses a funding model without adding debt to their balance sheet, which can help maintain a healthier credit profile.
Factoring does not require evaluation of a company’s credit history to qualify for the service. This makes factoring an accessible alternative for small businesses with limited credit history or financial strain.
Less time spent collecting payments
Tracking down customer payments month after month is time consuming and stressful. It may be one of the main reasons your business is considering AR factoring in the first place. That task can strain client relationships and keep you on edge about whether you have the cash reserves to pay your own bills.
If you work with a factoring company that offers non-recourse factoring services, you can stop chasing down late payments—the factoring company becomes responsible for getting your customer to pay. With non-recourse factoring agreements, the factoring company assumes any risk of potential non-payment and takes the invoice off your books.
FYI, accounting for factored accounts receivable is done a bit differently than typical AR accounting.
Improved business stability
Regular cash flow improves business stability. You can pay your bills on time and invest back in your business. Flexibility with finances also improves stability in other ways.
The operational benefits of factoring can foster positive relationships between your company and the people and businesses that rely on it. Employees are more satisfied when they receive on-time paychecks and have access to sufficient resources. Suppliers gain more trust as you consistently place orders.
Even customers can benefit as your business establishes credibility. Over time, this stability supports steady growth and profitability.
Potential risks that come with factoring
As you can see, factoring comes with many benefits—and even some advantages over traditional AR financing. But what is the risk of factoring receivables? You may have to deal with:
- Costs and fees. The fees associated with factoring can add up quickly. You may be charged up to 6% of each factored invoice in standard fees. Additional costs, such as daily rates, credit check fees, and monthly account fees can further reduce your income. If factoring becomes a regular part of a business’s financial operations, it can significantly reduce profit margins over time.
- Loss of control over collections. In most factoring arrangements, the factoring company takes over collections. While this appears to free you from administrative duties, it also puts a third party into your customer relationships. Customers may dislike working with a factoring company or see factoring as a sign of financial difficulty, straining their relationship with your business.
- Customer non-payment. If customers don’t pay the amount owed on their invoices, you may have to buy those invoices back. Factoring companies that use recourse factoring often have this requirement built into their contracts, while those who engage in non-recourse factoring don’t require buying invoices back. You’re off the hook no matter what happens.
- Dependence on factoring. Some companies become dependent on factoring to access their money rather than using it as one tool in a diversified cash flow strategy. Once a company becomes reliant on factoring in this way, breaking out of it can be challenging, potentially putting more financial stress on the business.
Hopscotch Flow as an alternative to factoring
Traditional AR financing and factoring aren’t your only options for cash flow management. Hopscotch Flow bypasses some of the most common downsides of factoring to offer you greater financial flexibility and benefits. Here’s what you can expect:
- More money upfront: Flow gives you access to 90% of your invoices in just a few clicks.
- No hidden fees: You know exactly how much factoring costs, and there are no additional fees for administrative tasks like credit checks.
- Guaranteed privacy: You maintain control over your clients and relationships, who never have to know you used Flow on their invoice.
- Safely grow your limit. The more on-time repayments you make, the more your borrowing limit can grow.
Get paid faster with Flow without the downsides of AR factoring.
Bret Lawrence
Writer
Bret Lawrence writes about invoicing and cash flow management at Hopscotch. Her previous roles include senior financial writer at Better Mortgage, where she covered lending and the home buying process. Her writing is not financial advice.
