Account Receivable Factoring: A Basic Introduction
For a small business owner, an entrepreneur or a startup company, cash flow issues between invoicing a customer and receiving payment for the work or product can create a real problem. To address this issue, savvy business owners in this position turn to account receivable factoring as a solution to the problem.
There is often some confusion about the specifics of account receivable factoring and how it impacts their business. To clarify the process, and to explain the benefits of this option, the following information will be of help to those new to the idea.
What is Factoring?
Factoring, or more correctly account receivable factoring, is one of the oldest forms of businesses accessing cash to address the gap between invoicing and payment. Most business to business sales occur on a thirty, sixty or ninety-day term, which means there is a one to three months wait time for the seller to be compensated.
Once the transaction is completed and the buyer is presented with the invoice, the seller is acting as the financer of the transaction. A factor, a third party business, can buy those open invoices from the seller for a percentage of the face value of about 80%, and assumethe role of financer.
The seller is then provided with the funds by the factor as per their agreed upon terms. The factor holds the balance, the 20% and waits to collect from the buyer, freeing up the seller from these duties.
Once the buyer has paid the invoice, the factor deducts the fees for their service, which are determined and outlined in advance, and forwards the residual amount of the held funds to the seller, completing the transaction.
In addition to addressing the cash flow issue, account receivable factoring also makes sense for small to mid-sized businesses over other funding options. It is not a loan, so there is no interest or repayment, rather the company offering the account receivable factoring service deducts their fees as a one-time charge.
Also, and something worth considering for any business, is that the business credit score and financial history is not considered by the company offering account receivable factoring. Instead, the creditworthiness of the buyers, who will be paying the factor as per the terms of the invoice, is the main consideration.