Invoice Factoring

Accounts Receivable Factoring: The Definitive Guide

Accounts Receivable Factoring: The Definitive Guide

It’s generally always nice to look at your balance sheet and see that people owe you money. This is cash that you can count on in the future. These are your accounts receivable. Accounts receivable often represent a positive statistic for a business. In short, your accounts receivable are any payments outstanding with your company. It’s always better to be owed money than to be the one that owes it.

Even so, a big number on your accounts receivable sheet is cold comfort if you can’t get paid. How do small and medium-sized businesses (SMBs) solve the problem of being paid on time for their accounts receivable? The answer is accounts receivable factoring. But what is it? How does it compare to accounts receivable financing? How can it help your business?

What is Accounts Receivable Factoring and How Does It Help Me?

Accounts receivable factoring is a way you can fund your business by financing your accounts receivable from late-paying customers. In accounts receivable factoring, also commonly known as invoice factoring or just plain factoring, a company’s accounts receivable act as collateral so a small business can quickly find the money it needs.

When small and medium-sized businesses require working capital fast, to bridge a cash flow gap, invoice factoring can be the most convenient and readily available option. A small business provides its existing, outstanding invoices to a third-party lender, who then advances up to 100 percent of the invoice value in exchange for a predetermined fee. This can all be a sweet deal for small businesses, but many SMBs still have questions about factoring and what it means in today’s market. Our definitive guide on the nature of factoring and what you should know to make your accounts receivable more than a reminder that you can’t get paid.

Why Would a Small Business Need Accounts Receivable Factoring?

It’s not uncommon for large corporations to use net payment terms as a way to flex their muscles on smaller businesses. In fact, these companies will frequently require net terms as a cost of doing business. Few businesses can afford to decline orders of this size. These types of large scale orders can make or break a company. Because of this, small businesses are all too happy to bend over backward for their clients.

Unfortunately, these net terms become a problem when the SMB is still trying to secure payment more than a month later and it’s time to make payroll. These cash flow gaps create all sorts of problems for small businesses trying to make ends meet.

These one-sided net terms put SMBs between a rock and a hard place. On the one hand, there’s no cash flow without orders. Without the business of these large companies, many small businesses would be unable to sustain themselves. On the other hand, even a large order doesn’t mean much if a business cannot collect what it’s owed.

The SMB can do everything in its power to get clients to pay on time, but only up to a point. Bother a client too much and you can risk souring the business relationship with a client you can’t afford to lose.

As a result, businesses often continue to suffer through months without payment in the hopes that the client will eventually hold up its end of the bargain. However, more small and medium-sized businesses are beginning to realize that there is a third option available: accounts receivable factoring.

What are the Key Benefits of Accounts Receivable Factoring?

The main, and most obvious, benefit of accounts receivable factoring is getting paid on time. Thanks to the innovative online platforms used by factoring companies, the process of applying and getting paid has never been easier, or faster.

Finding Businesses the Funding They Need

Through the application of tech-enabled flexible factoring, business owners can apply, submit invoices, and receive funding in as little as 24 hours. Businesses simply upload their outstanding invoices, receive approval, and funds are deposited, often within the next day. A business can use invoice factoring to fund a nearly limitless supply of outstanding invoices. From invoices of less than $5,000 to amounts into the six figures, SMBs can find the capital they are looking for, fast.

Saving Business and Customer Relationships

Another major benefit to invoice factoring is how it can help to maintain positive relationships between businesses and their customers. Thanks to factoring, a business can find cash quickly while also extending the generous net terms required by the client. The small business no longer has to worry about tracking down payment from customers with outstanding invoices. This brings up a benefit unique to invoice factoring.

Focus on Business Instead of Getting Paid

One of the most annoying aspects of net terms goes beyond the inconvenience of getting paid on time. On top of missing out on money your business has already earned, you are then forced to spend valuable time trying to track down your payment. This is time that could be better spent actually doing business, rather than trying to get paid.

In invoice factoring, the small business sells the entirety of the existing invoice to a third party. What this means is that the small business no longer has any obligation to the outstanding debt. The factoring company completely takes on the outstanding invoice, warts and all. This also entails tracking down the payment for the invoice.

How Do I Decide Between Accounts Receivable Factoring vs Accounts Receivable Financing?

Accounts receivable factoring is often confused with accounts receivable financing. However, there are important differences that make these two forms of alternative lending very different from one another.

Accounts Receivable Financing is a Loan

Perhaps the most important difference between the two types of lending is that accounts receivable financing is more closely resembles an advance or a loan. Your business is receiving an advance based on the amount of your existing outstanding invoices. This money is then paid back whenever the amount of the invoice is collected from your customer.

The drawback of this is that interest will accrue while you’re waiting to get paid. If you have a hard time getting your customer to pay what you’re owed, this interest could add up quickly.

Controlling How Your Money is Collected

An additional way in which invoice factoring differs from accounts receivable financing is in how the funds for your outstanding invoices are collected, and who collects them. As we established, factoring involves the sale of your outstanding invoice. 

Along with purchasing your invoice, your factoring company will undertake the task of collecting payment. While collection is often done discreetly and professionally, it pays to work with a reputable factoring company that you can trust to protect the reputation of your business.

In accounts receivable financing, your business is still the one on the hook for collecting what your owed. This makes financing a solution that may be more ideal as a short-term, stop-gap solution for cash flow problems.

An Innovative Cure for Cash Flow Woes

It all comes down to a matter of getting paid. It’s more than inconvenient when your company can’t get paid promptly. It’s unfair. This is money that your business earned. Anything less than full payment, on time, is an insult to you and your business. Unfortunately, the prevalence of this behavior, and the tolerance of it, has become the norm.

Through accounts receivable factoring, businesses can still offer net terms to their clients while also getting the money they need, when they need it. There’s no need for a business to wait to get paid. Invoice factoring puts the power to control cash flow back where it belongs: in the hands of business owners.