Accounts receivable (A/R) financing also referred to as factoring, allows the business owner to receive capital in the event you are owed money for services completed (unpaid invoices or A/R). This can be optimal because the focus is on the business that owes the receivable and not the company receiving the advance.
In it’s truest form, factoring isn’t really a loan as much as it is the sale of an asset. The small business owner is selling his or her A/R to a factor, who then collects from your customers. You get a percentage of your receivables up front and the balance (minus what the factor takes) when the invoice is collected.
A/R Financing in a Nutshell
Simply put, A/R financing is turning your company’s accounts receivables into immediate cash. Let’s take a look at a quick example to better understand.
Your small business has $100,000 in receivables. You send those invoices to your lender and supplier. The lender will fund you a given percentage of the invoices, typically between 75 and 80 percent depending on a variety of factors, such as, age and quality of the receivables. With customers like Walmart or Target, the percentage will likely be much higher.
At this point, the lender holds the invoice, you hold the percentage so far paid out by the lender, and your customer will pay the invoiced amount to the lender. Once the customer is ready and pays off the invoice, the lender will then pay you the remaining balance of the invoice – minus their fees.
If your business is in a crunch because you have provided your services and payment is not collected for 30 days or more, there are financial factoring companies that can help. These factors will take a look at your clientele who is owing you payment and depending on the credibility of your customer the factor will advance you funds and then collect the invoice from your client to pay the advance off. The rates for this type of funding are generally lower than what you would receive with a cash advance loan or a daily payment loan depending on the strength of the creditor.
Types of A/R Financing
Accounts Receivable: (Factoring) is the selling of purchase orders or accounts receivables for cash now.
Purchase Order Financing: Is a secured type of loan, by either a purchase order or contract, to pay for inputs, in which, are needed to produce and ship a product or deliver a service.
Inventory Financing: Is a form of asset-based lending that allows businesses to obtain a revolving line of credit when they use their inventory as collateral.
Asset Based Lending: Any type of business loan secured by collateral. A loan or line of credit that is secured by inventory, A/R, or balance sheet assets.
Single Invoice Factoring: Is a business financing option that lets you advance the payment of your customer’s pending purchases.
Factoring is one of the oldest means of financing in the world. In years past this was 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 been harder to come by.
Factoring could be a good fit for your company if your accounts receivables are stretched and causing you cash flow problems. It’s also a possible way to acquire funds to take advantage of a special offer or profit opportunity. If you find yourself spending a lot of time in collections or need quicker access to some cash to take advantage of supplier discounts, factoring could be an option for you.
Is A/R Financing Right for You?
This type of financing is valuable when a contract for products or services is received, but the business lacks the cash to fulfill on the contract. Businesses utilizing this type of loan will most likely experience; lower interest rates and time savings. These types of financing are innovative, unique, and easy for a business to qualify for but must be used in the right situations.
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