Accounts Receivable Factoring: The Definitive Guide
It’s usually a great situation when your balance sheet shows that clients owe you money.
You have peace of mind knowing you can rely on future sources of cash flow.
These outstanding payments are your accounts receivable. Accounts receivable typically represent a positive metric for your business. However, a large number of outstanding invoices can create problems if you don’t receive timely payment from multiple customers.
So, how do small and medium-sized businesses (SMBs) ensure they can receive payments for their accounts receivable on time, every time? The answer is accounts receivable factoring.
In this post, we discuss the role of invoice factoring, how it compares to accounts receivable financing, and how it would help your business?
What is Accounts Receivable Factoring, and How Does It Help Me?
Accounts receivable factoring can fund your business by financing outstanding invoices from late-paying customers. This practice, also known as invoice factoring or just “factoring,” allows a small business to use accounts receivable as collateral to obtain the funding it needs.
When SMBs require fast working capital to bridge a cash flow gap, invoice factoring can offer a convenient, low-cost option.
It works like this: 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.
The small business receives quick, easy cash flow. The business owner can fund one or multiple invoices and get paid within one business day.
Why Would a Small Business Need Accounts Receivable Factoring?
Large corporations commonly use net payment terms as a way to flex their muscles at smaller businesses. Larger companies will frequently require net terms as a cost of doing business with them.
Few businesses can afford to turn down large-sized orders. These orders can make or break a company’s profitability. Therefore, small businesses will bend over backward for larger clients.
Unfortunately, these net terms become a problem when the SMB is still trying to secure payment more than a month later. By this point, the company might need to make payroll or pay off suppliers.
The nature of these relationships creates a problem. Without large orders, many small businesses struggle to sustain themselves. However, a large order doesn’t mean much if the company can’t collect payment.
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 risk souring a business relationship with a firm you can’t afford to lose.
Businesses can suffer months without payment. They will hold out hope that late-paying customers will hold up their end of the deal. An sometimes, those payments never arrive.
More SMBs should realize that a better deal exists: accounts receivable factoring.
What are the Key Benefits of Accounts Receivable Factoring?
The primary benefit of accounts receivable factoring is obvious. SMB owners get paid on time on their terms. There’s no more waiting 30, 60, or even 90 days for payment. Factoring companies provide access to working capital within one day of submitting an invoice.
Finding Businesses the Funding They Need
Tech-enabled, flexible factoring lets business owners take control of their cash flow. A person can upload outstanding invoices, receive approval, and receive funds within a business day.
The rules are equally simple: A firm can fund one or multiple invoices all at once. Invoice factoring allows companies to access outstanding customer payments ranging from less than $5,000 to amounts well into the six figures.
Save Business and Customer Relationships
Financing your accounts receivable allows your business to maintain positive relationships with your new and existing customers.
The process allows a company to access capital quickly. However, it also allows a firm to meet the generous net terms required by a client. The small business no longer needs to worry about tracking down outstanding payments from customers.
Focus on Business Instead of Getting Paid
One of the most annoying aspects of net terms goes beyond the inconvenience of late payments.
On top of missing out on money owed to your business, you must now spend valuable time tracking down your payment. A company owner could better use this time managing a business.
When small business owners sell existing invoices to a third party, they no longer have obligations to the outstanding debt. The factoring company takes on the invoice and tracks down payment.
How Do I Decide Between Accounts Receivable Factoring vs. Accounts Receivable Financing?
Many people confuse accounts receivable with accounts receivable financing. Important differences exist between these two forms of alternative lending. Here are a few examples:
Accounts Receivable Financing is a Loan
The critical difference between the two lending types is that accounts receivable financing more closely resembles a loan advance. In this case, your business receives an advance based on the amount of your existing outstanding invoices. After you receive funding through a invoice financing platform, you pay back the loan upon receipt of your customer’s payment.
The drawback to invoice financing services is the interest, which accrues while you await customer payment. If you have a hard time getting customers to pay in a timely manner, interest can add up quickly.
Controlling Payment Collection
Another key difference between invoice factoring and accounts receivable financing is the method of collection for outstanding invoices. As we established, factoring involves the sale of your outstanding invoice. But who collects the outstanding payment is a critical difference.
After purchasing your invoice, your factoring company is responsible for collecting payment. While the collection is often done discreetly and professionally, it pays to work with a reputable factoring company you can trust to protect your business’ reputation.
In accounts receivable financing, your business remains responsible for collecting outstanding payments. Financing may be an ideal short-term, stop-gap solution to address cash flow gaps.
An Innovative Cure for Cash Flow Woes
It all comes down to timely payments.
It’s not just inconvenient when customers don’t pay on time. It’s also unfair.
This outstanding payment is money your business earned. Anything less than full payment, on time, is an insult to you and your business. Unfortunately, the prevalence and tolerance of late payments have become the norm.
Accounts receivable factoring allows businesses to offer net terms to clients while they can quickly access the money they need when they need it. There’s no need for a company to wait for payment. Invoice factoring puts the power to control cash flow back where it belongs: in the hands of business owners.