The phrase accounts receivable factoring is also called invoice discounting. It comes into play when an organization plans to sell its receivables at a decreased or discounted rate to a third party and, in return, receives immediate cash. Here the third-party firm is called the ‘factor’. The account receivable factoring helps increase the cash flow by providing quick access to the necessary funds instead of waiting for days and months like 30, 60, or even 90 days to get the submitted invoice cleared.
What Do You Mean By Accounts Receivable Factoring?
A special type of financial management allows a company to earn immediate cash after selling their total or a certain part of receivables amount to a third-party called ‘factor’. Generally, it is sold at a discounted rate to the third party, and in return, it gets the immediate necessary cash from the factors.
The price that a factoring agent pays against an invoice depends on a variety of facts & conditions. They are:
- The amount of the bill or invoice
- The probable time that the client will take to pay against the invoices
- The creditworthiness of the client
- The history of the Collection of the company
- Any Due date of the accounts receivable
- The Industry that the company belongs to
- The discounted rates at which the factoring agency buys the receivables can vary widely and can even go up to 4% and come down to even 1%, depending on the abovementioned factors.
Benefits Of Account Receivable Factoring
The following are the benefits of the accounts receivable factoring. Read on to know more.
- Account receivable factoring is one of the most common yet simple forms of commercial finance, which requires a good client base and satisfactory credit amount to reap the benefits.
- The process does not require you to reveal your credit history. So in case you have bad credit reports or are unoperated for a long time, you can easily take advantage of your client’s credit history to get immediate cash.
- Once you sell the invoice to the factor, you no longer have to chase the client for the payment as it is the responsibility of the factoring agency now to chase for the payment. And once the payment is made, the amount will be returned to the company they have brought the bill from by excluding their fees.
- Cash flow plays a crucial role in the growth and success of a business. The speed of cash flow can get hampered easily when the business’s revenue is stuck due to unpaid receivables, which affects the payroll and overhead costs of the company. In such cases, accounts receivable factoring can be the ultimate savior.
- Factoring is not some loan; therefore, it will not affect a business’s overall credit ratings and the interest rates at which they can borrow money, thereby helping businesses have cash. Therefore the system helps to boost the revenue generation process of a business and can easily create a working capital reserve for a start-up for its future growth and development.
Companies willing to take loans often from the bank or financial institution are likely to come under the high credit risk category. Most of the time, they must submit collateral and make monthly payments throughout the tenure, which might affect their cash flow when the business generation is low. In such cases, the accounts receivable factoring can immensely help them take hold of their accounts and revenue generation.
What Is The Cost Of Accounts Receivable Factoring
The cost depends on the following.
- Discount charge – It varies from 0.5% to 5% and is calculated on the value of the billing amount.
- Credit Management fee – It is the cost required for credit checking the buyer and the administration costs for providing the service.
- Credit protection fee – In non-recourse factoring, where the lender takes the risk for non-payment credit protection fee is required.
- Notice period to end the service – It varies greatly, but all charges must be paid during this notice period time.
Whether you’re a startup, have bad credit, or need access to quick cash to maintain operations or invest in expansion, factoring receivables may be a viable option for your business if you’re having cash flow difficulties or experiencing rapid growth and can’t get bank loan funding. When you sell your receivables to a factoring company, you can have access to cash quickly without having to put up collateral or sign a long-term contract, both of which are necessities for maintaining a healthy cash flow and, thus, a successful business. As a result, factoring can help your business stay afloat and expand while relieving some of the stress associated with collecting outstanding invoices at varying costs.