What You’ll Learn:
- What accounts receivable factoring is
- The benefits of accounts receivable factoring
- The costs of accounts receivable factoring
If you run a business, you know the struggle of waiting for invoice payments to hit your account. Getting access to accounts receivable gives you the capital to complete other business transactions, but payments aren’t always made when you need them. And hassling your customers about these payments can spark awkward conversations that jeopardize valuable relationships, Accounts receivable factoring provides relief from this frustration and gives you flexibility with your finances.
Learn more about it so you can determine whether factoring receivables is a good idea for your business.
What is accounts receivable factoring?
Accounts receivable factoring is a service businesses can use to gain access to funds. Unlike accounts receivable financing, accounts receivable factoring is not a loan. Rather than using invoices as collateral, a business sells their invoices to a third party called a factoring company.
The factoring company advances a percentage of the invoice to your business and takes over collections on the original invoice. Once the invoice is paid in full, the factoring company releases the rest of the invoice amount (minus fees) to your business.
Benefits of accounts receivable factoring
Why engage in AR factoring as a small business? Here are a few reasons:
Improved cash flow
Factoring provides companies with immediate cash flow. By accessing invoice payments upfront, companies can put that cash to work rather than waiting to take action. The cash can go toward payroll, supplies, events, or other investments.
Factoring can also be used in tandem with other cash management strategies such as cash reserves, expense management, and cash flow forecasting.
Credit flexibility
Most traditional financing models require a check on your credit history. Factoring doesn’t require checking your business’s credit history, making it an excellent option for small businesses or new businesses with limited credit history.
Instead, a factoring company looks at the details of the invoices you want to factor and they assess the creditworthiness of your customers. If you have reliable customers, a factoring company is likely to approve their invoices for purchase and front you the cash.
Potential business growth
Early access to capital gives businesses more opportunities for investment and growth. If an unexpected opportunity arises, you can seize it right away. You don’t have to risk missing out while you wait until your invoices come due.
As you carefully allocate money toward expenses, you can also build relationships with clients and suppliers. Strong relationships give you stability as you expand.
How does accounts receivable factoring work?
Factoring involves three parties:
- The business that sells the invoices
- The factoring company, or “factor”, that purchases the invoices
- The customer who owes money on the unpaid invoices
Here’s how the process works:
- The business submits receivables to the factor.
- The factor approves the invoices for factoring by checking the customer’s credit.
- Once approved, the factor advances a percentage of the invoice value to the business.
- The factor collects payment from the customer.
- The factor remits the balance (minus fees) to the business.
Want more details? Learn about how invoice factoring works and how to account for factored receivables.
Recourse versus non-recourse factoring
The process for factoring may differ slightly, depending on whether you choose to engage in recourse or non-recourse factoring.
With recourse factoring, you retain liability in the case of customer non-payment. The factoring company may require you to buy back any unpaid invoices (in other words, give them back the amount they advanced to you). With non-recourse factoring, the factoring company assumes all risk of customer non-payment. The invoice is completely removed from your books, and you do not have any responsibility if a customer fails to pay.
What are the costs of accounts receivable factoring?
Before you engage in accounts receivable factoring, you should understand the costs. These are the numbers you need to know:
Advance rate
You don’t get the entire invoice amount upfront when you use factoring. The exact amount varies, but most factoring companies offer at least 70% of the total amount upon sale of the invoice. With Hopscotch Flow, businesses receive 90% of the total invoice amount instantly. The rest of the invoice amount (minus fees) is paid out after the customer pays the invoice.
Factoring fee
The standard factoring fee varies as well, with most companies charging between 2% and 5% of the total invoice amount as a processing fee. With multiple invoices or large invoice amounts, the factoring fees can be substantial.
Additional fees
Some factoring companies charge other fees in addition to the standard factoring fee. They may charge monthly account fees, credit check fees, origination fees, or other service fees. Be sure to consult your contract to understand all fees involved.
These rates can differ based on several factors, including your industry and invoice volume. It’s typically more expensive to factor invoices for customers with poor credit. Non-recourse factoring typically has higher fees as well.
One benefit of accounts receivable factoring over other options like AR financing is that you know all the costs upfront, so you can make an informed decision about your money.
Related: Invoice factoring fees: How much and how fast do they add up?.
Hopscotch Flow as an alternative to invoice factoring
Hopscotch Flow makes invoice factoring even easier, taking fewer fees out of your payment and giving you more control over your money.
Flow your first invoice with Hopscotch and get paid faster.
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.
