Accounts Receivable Factoring Might Be A Good Option For You

Factoring has been around for a long time. It’s how the early explorers financed their travels to the new world and how ancient civilizations funded their caravan expeditions into the Far East. It’s one of the oldest financing methods available. What’s more, in some industries, it’s still the financing vehicle of choice.

What Is AR Factoring?

In its truest form, factoring isn’t really a loan as much as it is the sale of an asset. In Accounts Receivable (AR) factoring, you sell your AR to a factoring company, which then collects from your customers. You get a percentage of your receivables up front and the balance (minus the factoring fee) when the invoice is collected.

Previously, this strategy was often considered a financing measure of last resort. But over the last few years, it has become more popular as traditional financing from banks and credit unions has become harder to come by.

What Are The Benefits Of AR Factoring?

Depending upon your customer base and the state of your AR, factoring your receivables is usually much easier and faster than securing a conventional loan. What’s more, the factor is more interested in the credit worthiness of your customers than whether or not your credit is perfect. So even if your credit score is below average, you could still qualify for this type of financing, if the other aspects of your business are strong. 

Some factoring companies specialize in specific industries and business types. Finding a factor that specializes in your industry could improve your chances of approval. 

How A/R Factoring Works

1. Business sends the invoice to the customer and the funder.
2. Funder advances you up to around 80% of the face value of the invoice.
3. When the invoice is due, the funder collects payment from the customer.
4. Once the funder has been paid, you receive any remaining balance minus the agreed-upon fee.

You’ll usually end up selling your AR for a fee between 2% and 5%, depending on how easy or difficult it will be for the factor to collect. Expect to negotiate the terms based upon:

• Your customer’s past payment history
• The volume of invoices
• The average invoice size
• The average number of days until payment

You can choose whether to sell all your invoices or just some of them to the factoring company. However tempting it might be, the factor doesn’t want your customers who are traditionally slow. Instead, the company will likely prefer those invoices that are most likely to get paid on time.

AR Factoring Vs. AR Financing

The two are very similar. The primary difference lies in who collects on the invoice from the customer. With AR financing, the business collects on the invoice from the customer and pays the financing company back + a fee. With AR factoring the financier collects on the invoice. 

How To Qualify For AR Factoring

1. Be a B2B or B2G business with outstanding accounts receivables.
2. Meet minimum revenue requirements—most financiers will have a minimum annual revenue requirement
3. Meet time in business requirements—this requirement can range from no minimum to one year.
4. Have creditworthy customers with a positive payment history—financiers will focus more on whether your customers are likely to repay their invoice rather than your own credit score.

Types Of AR Factoring

There are two types of factoring options you should be aware of:

1. Full-service factoring – The factor assumes full responsibility for and control of collecting the debt, even if the customer never pays the invoice. The factor assumes all the risk. As you might expect, this type of factoring carries with it a higher discount when they purchase your AR.
2. Recourse factoring – If your customer doesn’t pay the invoice, you are obligated to buy it back. Recourse factoring allows you to sell your AR at a small discount and is great if your customers have a history of paying on time.

Factoring allows you to leverage your AR now to fill a short-term need for capital. For example, if you sign a new contract that will substantially help your business, but you need some cash to gear up to fulfill it, factoring might be a very good way to acquire the capital you need. Industries that frequently use factoring include textiles, trucking, wholesalers, and distributors. 

When looking for a factor, be aware that they are not all alike. Interest rates and terms can vary greatly. It’s easy to find this type of financing online. Lendio‘s network partners with multiple factoring and other financing companies to compare multiple offers so you’re sure you get the best deal on your next business move.

AR Vs Purchase Order Financing

The following graphic illustrates key differences between AR and purchase order financing. For more information on purchase order financing, visit this post.

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The information in this blog is for informational purposes. It should not be used as legal, business, tax, or financial advice. The information contained in this page is Lendio’s opinion based on Lendio’s research, methodology, evaluation, and other factors. The information provided is accurate at the time of the initial publishing of the page (July 26, 2022). While Lendio strives to maintain this information to ensure that it is up to date, this information may be different than what you see in other contexts, including when visiting the financial information, a different service provider, or a specific product’s site. All information provided in this page is presented to you without warranty. When evaluating offers, please review the financial institution’s terms and conditions, relevant policies, contractual agreements and other applicable information. Please note that the ranges provided here are not pre-qualified offers and may be greater or less than the ranges provided based on information contained in your business financing application. Lendio may receive compensation from the financial institutions evaluated on this page in the event that you receive business financing through that financial institution.