What to Do if A Bank Rejects Your Loan Application
If a bank rejects your business loan application, you’ll likely experience a mix of emotions. The feeling after a loan rejection could range from frustration
Menu
Key Summary Takeaways about Factoring Accounts Receivable:
- Understanding Accounts Receivable Factoring: Accounts receivable factoring allows businesses to sell unpaid invoices to a factoring company for immediate cash flow. This alternative financing method helps businesses avoid traditional debt and ensures they can meet urgent financial obligations.
- How Factoring Works: The process involves providing business and customer information to the factoring company, underwriting to evaluate credit risk, receiving term sheets, verifying invoices, and obtaining advance payments (typically 75-100% of invoice value). Customers of the business then pay the factoring company directly.
- Key Benefits: Factoring offers rapid access to funds, avoids new debt, reduces administrative burdens, and provides flexibility. It’s particularly useful for industries like manufacturing, trucking, IT, and government contracting.
- Types of Factoring: Options include recourse and non-recourse factoring, notification and non-notification factoring, spot factoring, and whole turnover factoring, each catering to different business needs and risk preferences.
- Choosing the Right Partner: Businesses should prioritize transparency, ease of use, and customer experience when selecting a factoring company. FundThrough, for example, offers 100% advance rates, no hidden fees, and seamless integration with accounting software for efficient financing.
Navigating the ebb and flow of business finances, especially for small and medium-sized businesses, can be daunting. A report by PYMNTS confirms this, finding that 60 percent of small businesses struggle with cash flow management.
As entrepreneurs, we stand in solidarity with small business owners. We understand the headaches that can happen with small business financial management. This accounts receivable factoring guide will tell you everything you need to know to decide whether it’s right for you.
What is accounts receivable factoring?
Accounts receivable factoring is a financial transaction where businesses sell unpaid invoices to a factoring company at a discount. This provides immediate cash flow. The factoring company collects payments from customers, allowing businesses to focus on operations without waiting for customer payments.
Step-by-step guide: How accounts receivable factoring works
With accounts receivable factoring, businesses can usually expect a streamlined and efficient process that speeds up their access to working capital, freeing them from the constraints of traditional payment cycles. See. how it works in this infographic if you’re a visual learner, or get a step-by-step written breakdown below it.
What’s the process of factoring accounts receivable?
- Provide information on your business and customer: To assess whether they can work with you, the factoring company needs details about your business, such as financials and articles of incorporation. You’ll also need to provide customer contracts and the invoices you’d like paid early. This helps the factoring company underwrite you and your customer.
- Underwriting your business and customer: The factoring company conducts a thorough evaluation of your business and your customers’ credit profiles. This step ensures that both your business and your customers meet their risk criteria for advancing funds. While your company’s financial health matters to the final decision, your customer’s creditworthiness is more important.
- Get term sheets: The factoring companies who can work with you provide a proposal outlining the credit terms and other aspects of the factoring agreement, including the advance rate, fees, and other conditions. This gives you a clear understanding of the costs and benefits of factored receivables before proceeding and an easy way to compare different offers.
- Verifying invoices: The factoring company verifies the validity of your invoices by confirming that goods or services were delivered and accepted by your customers. This step ensures that the invoices are legitimate and collectible.
- Get paid: Once the invoices are verified, the factoring company advances a percentage of the invoice value to your business, typically within 24-48 hours, to relieve your cash flow issues. This is called an advance rate, and they vary between 75% to 100% depending on the factoring company. (Not every factoring company requires advance rates. FundThrough pays 100% of your invoice up front less fees.)
- Customer pays invoice: Your customer pays the invoice directly to the factoring company according to the original payment terms. If you got your invoice paid in full upfront less fees, the process is complete at this step.
- Receive remaining invoice balance: If your factoring company doesn’t advance you 100% of your invoice value, they will pay you the rest of the invoices, less any fees.
Ready to explore accounts receivable factoring?
Factoring accounts receivable formula: How much funding can I get?
The short answer:
The amount of funding you can get with accounts receivable factoring depends on the value of your invoices. Typically, factoring companies advance 75-90% of the invoice value upfront. The remaining balance, minus fees, is provided after customers pay the invoices. Larger invoices or reputable clients may lead to higher funding percentages.
The detailed answer:
You can use a simple accounts receivable factoring formula to calculate an estimate of the funding you can get.
(Dollar amount in eligible A/R X Advance Rate) – factoring fees = working capital unlocked for your business
Beyond the obvious differences between companies in their advance rates and how they determine eligible A/R, the exact amount of funding you receive varies between factoring companies because of:
- Discount rates: Also known as the transaction fee, this is the percentage of the invoice the factoring company withholds from your advance as payment.
- Hidden fees: These are all kinds of hidden fees out there; these are just a few examples with typical dollar amounts include:
- Monthly maintenance fee: $600/month
- Lockbox fee: $200/month
- ACH fee: $10 per ACH
- Initial setup fee: 1% of facility
- Monthly usage monitoring fee: $100 per payor
What is an example of accounts receivable factoring?
The short answer:
An example of accounts receivable factoring is when a business sells its unpaid invoices to a factoring company at a discount. For instance, if a business has $50,000 in outstanding invoices, it might sell them to a factoring company for $45,000. The business gets immediate cash while the factoring company collects the payments from customers.
The detailed answer:
An accurate example depends on the pricing strategy the factoring company uses. Two common options are flat rates and daily rates.
- Flat rate: It’s exactly what it sounds like. The factoring company charges a flat percentage for every invoice by lengths of standard payment terms. (i.e., 30 or 60 days). Example:
- Invoice face value: $100,000
- Advance rate: 100%
- Flat rate: 2.75% per 30 day net terms
- Total fees, assuming on-time payment and no additional fees: $2,750.
- Daily rate: When an invoice factoring company uses a daily discount fee, the arrangement comes with an advance rate. For a simple example, let’s say they send you 80 percent of the invoice value immediately and hold back the remaining 20 percent. The daily fee would begin to accrue from the day of the advance and would stop accruing once your customer pays. Your factoring company partner then sends you the remaining 20 percent less the accrued fee amount. The upside of a daily rate is that you’re only ever charged for the exact number of days that your invoices are unpaid.
- Invoice face value: $100,000
- Advance rate: 80%, for an immediate payment of $80,000
- Hold back: 20%, a.k.a., $20,000
- Daily rate = 2.75%/30 days = 0.09167% per day
- Total fees, assuming on-time payment and no additional fees: $2,750
- Remitted amount: $17,250, once payment is received
Types of Accounts Receivable factoring
Across these different types of factoring services, the basic way the financing works is the same – you get outstanding invoices paid early – but key details of the arrangement vary.
- Recourse factoring: The business retains the risk of non-payment; if the business’ client fails to settle the invoice, the business has to repay the advanced funds to the factoring company, often via chargebacks or holdbacks from future advances. This option often features lower service fees due to the lower risk for the factoring company. –
- Non-recourse: On the other hand, non-recourse factoring shifts the credit risk of bad debt to the factoring company; the business is not responsible for repaying the advance if their client defaults. This added security for the business comes at the cost of higher factoring fees, reflecting the increased risk the factoring company assumes. The choice between recourse and non-recourse factoring hinges on the business’s risk appetite, the true non-payment risk, the price their willing to pay, and its clients’ credit histories.
- Notification Factoring: Your customer is informed about the factoring arrangement so they can redirect future payments. Because businesses have understandable concerns about a factoring company damaging customer relationships , it’s important to learn about how a potential partner will work with your customers. The upside to this arrangement is that the factoring company takes on collecting and managing your A/R. Here’s how FundThrough works to ensure a positive customer experience.
- Non-Notification Factoring: Your customer never knows that remains unaware that you’ve sold its invoices to a factoring company. If you meet certain credit requirements and/or if you have a large amount of receivables to get paid early, the factoring company will open a lockbox account with a banking partner. Then, you can ask your customer to redirect their payment to your new bank account.
- Whole Turnover (or Full Turnover) Factoring: Whole turnover factoring involves redirecting payment of all eligible invoices or accounts receivables to the factoring company for as much cash flow upfront as possible. This is can be a requirement in traditional factoring agreements.
- Spot Factoring: Spot factoring, also known as single invoice factoring, allows businesses to choose the individual invoices they want to sell to the factoring company instead of their entire accounts receivable. This is a flexible approach that enables you to get flexible funding anytime. (By the way, FundThrough offers spot factoring!)
- Accounts Receivable Financing: Depending on the factoring company, this is either a broader term that refers to borrowing money against outstanding invoices to skip the period of time waiting on net terms, or a completely different service. With accounts receivable financing that’s a distinct service you retain control over your receivables and collections, while the lender uses your invoices as collateral that you can draw against as needed and pay back on agreed upon installments – much like a line of credit against your receivables.
- Invoice Discounting: Invoice discounting involves using unpaid invoices as collateral to secure a loan or advance from a financing company. The difference between this and A/R financing is that you get a lump sum up front, and you pay back the lender once your customer pays you (plus fees).
Benefits of Accounts Receivable Factoring
Navigating business growth relies on smart cash flow management, especially when delayed payments from clients put companies in a difficult situation. That’s where accounts receivable factoring comes in as a key solution converting those outstanding invoices into quick cash, sidestepping the debt trap that traditional financing like bank loans or lines of credit can cause. (Or even alternative financing methods like merchant cash advances Key Benefits of Accounts Receivable Factoring:
- Rapid Access to Funds: Factoring converts outstanding invoices into cash, typically within a day (after your first funding), bolstering your business’s cash flow and enabling you to address immediate needs or seize new opportunities.
- Avoidance of New Debt: Unlike bank financing or MCAs that add to your company’s liabilities, factoring involves selling your receivables, keeping your balance sheet clean and your debt-to-equity ratio healthy.
- Ease of Approval: The focus on your customers’ creditworthiness rather than your own makes it simpler for businesses, especially newer ones, to qualify for factoring, sidestepping the rigorous scrutiny of traditional bank loan applications.
- Reduced Administrative Costs: With a factoring partner handling collections, your business can redirect valuable resources from chasing payments to core operational and growth activities. (But if you’re concerned about customer contact, learn FundThrough’s approach for working with them.)
- No Dilution. Because factoring is non-dilutive funding , you get the working capital you need without giving up control of your company.
- Flexible Financing: AR factoring lets you get the funding you need, anytime you need it, for growth opportunities, payroll, equipment, materials, and more.
Drawbacks of Accounts Receivable Factoring
While accounts receivable factoring presents a number of benefits, it’s important to consider a few potential drawbacks. One aspect to be mindful of is the factoring fees, which can impact your profitability, especially if you have to pay hidden fees on top of the discount rate. Additionally, the interaction between factoring companies and your clients during the invoice collection process requires a level of trust and transparency, as it directly involves your valued customer relationships. It’s crucial to partner with a reputable factoring company that respects and maintains the integrity of these relationships.
Industry use cases: Why get your invoices paid early?
While many industries benefit from early invoice payments, these six commonly factor their receivables for these reasons and more:
- Manufacturing: Manufacturers often use factoring for cash to cover supplies and overhead to make products before their customer pays for them.
- Trucking: Trucking companies frequently factor invoices to cover immediate operating expenses such as fuel, maintenance, and driver salaries. This ensures they can keep their fleet running while waiting for payments from shippers or brokers.
- IT: IT companies use factoring to manage cash flow for payroll and hardware while working on projects with long payment cycles. This enables them to invest in technology, hire specialized talent, and scale their services without financial delays.
- Oil and Gas: Oil and gas companies often factor accounts receivable to maintain cash flow to pay wages, buy equipment or materials, or to assure customers they’re well-capitalized to take on large projects.
- Government Contracting: Government contractors use factoring to bridge the gap between completing projects and receiving payment, which can take months. Factoring helps them cover payroll, purchase materials, and manage compliance costs.
- Construction: Construction firms rely on factoring to maintain steady cash flow while awaiting milestone payments. This ensures they can pay subcontractors, buy materials, and keep projects on schedule. (Please note that FundThrough can’t work with most construction companies.)
What to look for in an accounts receivable factoring company
- Immediate Cash Without the Wait: Opt for a factoring company that provides swift access to capital. The ability to turn invoices into cash quickly can be crucial for meeting urgent business expenses or capitalizing on immediate opportunities.
- A Positive Customer Experience. Make sure your factoring company contacts you before contacting your customers and has reps trained to interact professionally.
- Tech that drives efficiencies: A good factoring partner should make factoring easy. FundThrough’s tech-powered platform makes onboarding and funding easier with AI, automation, and offer integrations with your accounting software, like QuickBooks. This seamless connection simplifies the process, making it easier to manage your fundings.
- No Hidden Fees: Transparency in pricing is vital. Look for a partner that clearly outlines all fees upfront, ensuring you’re not caught off guard by unexpected costs, which can affect your financial planning. Remember that the rate doesn’t your reflect your total factoring cost.
- Dedicated Support: Personalized customer service can significantly enhance your factoring experience. A dedicated support team can provide tailored assistance, helping you navigate the factoring process with ease and ensuring your business always stays well-capitalized.
- Flexibility and Control: The best factoring companies offer the flexibility to choose which invoices you factor, allowing you to maintain control over your cash flow and financing needs according to your business’s specific situation.
- High Advance Rates: Consider companies that offer high advance rates on your invoices. Higher rates mean more immediate cash for your business, improving your liquidity and financial stability.
Choosing the right factoring partner involves assessing these critical factors to ensure their services align with your business objectives, offering not just financial solutions but also adding value through convenience, support, and flexibility.
Why factor your accounts receivable with FundThrough?
Opting for FundThrough to factor your accounts receivable is not just about speeding up your cash flow; it’s about embracing a more modern, tech-powered approach that makes it as quick and easy as possible to get working capital. Here’s why FundThrough stands out:
Key Advantages of Partnering with FundThrough:
- Unlimited Funding: With FundThrough, your capacity for growth is bound only by your eligible outstanding AR. We provide the funding to match your ambition, ensuring your business’s potential is never capped.
- Immediate Capital Access: Get your invoices paid in days, ensuring your business never misses a growth opportunity or payroll deadline.
- Unmatched Flexibility: Factor the invoices you choose, with no minimum funding requirements after the initial setup.
- Simplicity in Funding: With FundThrough, funding your invoices is as easy as a single click in the platform, once your customer is setup.
- No Required Funding: Many factoring companies require you to fund a certain amount of AR. FundThrough values your independence, allowing you to opt for funding only when it aligns with your business needs.
- Transparent Pricing: Our straightforward, single up-front fee structure means no hidden factor fees. For specifics, our pricing page is your go-to resource.
- Dedicated Personal Support: Your journey with FundThrough is supported every step of the way by a dedicated account manager, providing tailored assistance to navigate the funding landscape and ensure you always have the funding you need.
- Effortless Accounting Integration: Leveraging integrations with popular accounting software like QuickBooks, FundThrough seamlessly pulls in your eligible invoices for a streamlined experience.
- 100% Advance Rates: We offer 100% advance rates on your invoices, less our single fee, ensuring you have full access to the funds you’ve earned, right when you need them.
Ready to get paid early?
How do I qualify for accounts receivable factoring?
While every factoring company has more specific requirements, these are the basic qualifications for accounts receivable factoring across the industry:
- Creditworthy customers. Do you customers have a strong invoice payment history? Your factoring company will do credit checks on any customers whose invoices you’d like paid early.
- Minimum dollar amount in invoices to fund. Some factoring companies require a minimum amount for your first funding.
- No liens on your A/R (unless they can be removed). Factoring companies will check if you have UCC filings on your receivables. Sometimes, a factoring company will take second position on a lien if the first position institution is a reputable bank.
- No tax balance with CRA or IRS (or prove you’re in compliance with an established payment plan). You can’t have an unmanaged tax balance because the CRA and IRS can collect your receivables for back taxes.
- Meet company requirements. Some factoring companies have requirements for the businesses they work with, such as minimum time in business, minimum revenue, or acceptable industries.
Ready to get paid early?
Accounts receivable financing vs factoring: What’s the difference?
AR Financing and AR Factoring Similarities | AR Financing and AR Factoring Differences |
|
|
Comparison: Find the Best Financing for Your Business
In wrapping up, it’s clear that navigating extended payment terms, especially those stretching to 90 days, can significantly strain your business’s cash flow. Accounts receivable factoring emerges as a key solution, allowing you to convert those individual invoices into immediate capital. Partnering with a transparent and reliable factoring company simplifies this process, bypassing the complexity associated with conventional financing. This approach ensures a steady stream of working capital and focus on your business, empowering you to seize growth opportunities. It’s important, however, to thoroughly research and compare the advantages of factoring against other financing options to ensure it aligns with your business’s needs. A strategic partnership, founded on clarity and mutual success, can transform the way you manage cash flow, keeping your business poised for growth.
| Pros | Cons | |
|---|---|---|
| Accounts receivable factoring | Immediate cash flow improvement, Fast, flexible funding, Easy application and qualification | Difficult to record in bookkeeping, Collection efforts handled by the factoring company, Customer interactions are managed by a third party |
| Line of credit | Potentially lower interest rates, Flexible repayment schedule | Lengthy, slow approval process, Requires collateral and good credit, Limited funding, High rejection rate for small businesses |
| Merchant cash advance | Quick access to funds, Repayment adjusts with sales volume | Higher cost compared to other options, Can lead to a cycle of debt |
| Credit card | Readily accessible for most businesses, Flexible use of funds | High-interest rates can accumulate, Can negatively impact credit score if mismanaged |
FAQ
What’s the definition of accounts receivable?
Accounts receivable represent the money owed to a business by its customers for goods or services delivered but not yet paid for, essentially reflecting future cash inflows recorded on the balance sheet.
What is accounts receivable factoring?
Accounts receivable factoring is a financing option where businesses sell their outstanding invoices to a factoring company like FundThrough, receiving an advance payment on the invoice value, thereby converting invoices into cash to improve cash flow.
Is accounts receivable factoring a good idea?
Yes, for businesses facing cash flow challenges due to delayed payments, accounts receivable factoring can be a strategic tool to access immediate working capital without incurring debt, making it an effective solution to maintain steady operations and seize growth opportunities. (Get more information on if accounts receivable factoring is a good idea.
How to record factoring of accounts receivable?
Record factoring of accounts receivable by debiting “Cash” for the amount received, debiting “Factoring Fee” (or similar expense) for the costs incurred, and crediting “Accounts Receivable” for the total factored amount. If there’s a retained interest, credit “Liability for Recourse Obligation” or similar.
How does factoring your accounts receivables work?
Factoring accounts receivable works by selling outstanding invoices to a factoring company. The company advances a percentage of the invoice value immediately, holds the rest until the customer pays, and charges a fee for the service. Businesses use factoring to improve cash flow without waiting for customer payments.
Whats the cost of factoring accounts receivable?
The cost of factoring accounts receivable includes a factoring fee, typically 1-5% of the invoice value, and possible additional fees for an origination or early contract termination. Costs vary based on the net terms, customer creditworthiness, and individual factoring company rate differences.
What are the risks of factoring?
The risks of factoring include losing control over customer interactions, potential harm to customer relationships due to aggressive collection practices, high costs compared to other financing options, and customers not paying invoices.
Is factoring right for small businesses or startups?
Factoring can be suitable for small businesses or startups needing quick cash flow without qualifying for traditional loans. However, it may not be ideal due to high costs, reliance on customer creditworthiness, and the risk of strained customer relationships. Businesses should assess these factors before deciding.
What are typical factoring advance rates?
Typical factoring advance rates range from 75% to 95% of the invoice value. Higher rates are offered for customers with strong creditworthiness or low-risk industries, while lower rates apply to higher-risk clients or sectors.
In wrapping up, it’s clear that navigating extended payment terms, especially those stretching to 90 days, can significantly strain your business’s cash flow. Accounts receivable factoring emerges as a key solution, allowing you to convert those individual invoices into immediate capital. Partnering with a transparent and reliable factoring company simplifies this process, bypassing the complexity associated with conventional financing. This approach ensures a steady stream of working capital and focus on your business, empowering you to seize growth opportunities. It’s important, however, to thoroughly research and compare the advantages of factoring against other financing options to ensure it aligns with your business’s needs. A strategic partnership, founded on clarity and mutual success, can transform the way you manage cash flow, keeping your business poised for growth.
Ready to get your outstanding AR paid in days?
Suggested readings
Struggling with Unpaid Invoices? Here Are 7 Things You Can Do
Unpaid invoices are the bane of many small business owner. Not only do they lead to cash flow gaps and challenges, they can also make
Seven Foolproof Ways to Boost Your Cash Flow
No. 3 is a Game-Changing Way to Fund Small Businesses. You don’t need to be an accountant to understand the importance of cash flow management.