Receivable factoring – what are the top 5 benefits, and why should YOUR business do this?
If you need funding for your business, you may feel like you have nowhere to turn. However, the good news is there is always an opportunity to stay afloat. Instead of having to go into debt or potentially closing your new business, you can find a funding and financial method that lets you continue growing your business and your client base.
Many funding companies are usable for all industries. Instead of just usable for transportation industries or manufacturing companies, some funding methods are versatile for businesses in all niches and companies of various sizes. Whether you have a massive corporation or a small and new business, you can use this funding method to help you succeed.
Let’s see the top benefits of this funding method and why your business should use this!
What are accounts receivable factoring?
One of the most popular funding methods for startups and big corporations alike is accounts receivable factoring. Although It can sound confusing and more complicated than bank loans, the opposite is true. Accounts receivable factoring, also known simply as just factoring, is a financial method by which the company will sell its unpaid invoices to a finance company.
The unpaid invoices are known as receivables, which are benefits that can be cashed in for immediate payment. The unpaid invoices are a form of collateral, showing the worthiness and reputation of the company that needs the factoring services. The finance company that purchases the invoices will buy the receivables at a discounted rate, also known as the factor.
The discounted rate will be determined by the receivable factoring business, which usually comes in between 75% and 95% based on the company itself, the client’s credit scores, the company’s reputation, and other factors. For example, if your clients continually do not pay, you may only receive 75% of your invoice. However, if your clients always pay and have high credit scores, you may receive up to 95% of your unpaid invoice.
How do account receivable factors work?
To understand how account receivables work, you need to know the process of factoring. When looking for receivable factoring businesses, you need to make sure you find a high-quality and reputable company with a long-standing reputation with hundreds of previous clients.
After you choose a business, you need to know how the process works. Factoring is a financial transaction in which a company sells its receivables. The factor collects the payment on unpaid invoices from the company’s clients. If the clients do not pay, you will have to determine whether you or the factoring company pays the unpaid amount.
Companies choose factoring if they need immediate cash flow. If you need to pay your vendors, need to pay employees, or need to pay for repairs or services or your business, then you need to obtain factoring to avoid waiting for lengthy bank loan terms. For companies who are slowly going into debt and need cash fast to stay afloat, receivables factoring can help them avoid a negative financial state.
Furthermore, suppose the business wants to increase their reach, gain new clients, pay their vendors, or simply stay on good terms with their current coworkers and partners. In that case, they may need cash flow directly deposited into their account immediately. Instead of waiting for the long-term bank approval process that can take weeks or months, it will only take less than 24 hours for you to be approved for receivable factoring.
Factoring lets companies immediately build their working capital and improve their financial state without missing any payments or getting on bad terms with clients or coworkers. Therefore, factoring is a foolproof way to help new businesses and startup companies develop a positive reputation when trying to get on their feet.
Factoring allows companies to free up their capital for use on necessary resources and services instead of using capital merely to pay for daily expenses and track down unpaying clients. Receivable factoring helps new businesses avoid any risk and debt that comes with starting a company and lets them focus on what really matters – their products and services.
How account receivables are priced
The next step in using receivable factoring is figuring out how the account receivables are priced according to your business and the company you choose to use. Factoring companies typically have a factoring fee for their services. This fee can typically range depending on your business, your length of business, your client’s reputation, and your client list.
If you have trustworthy clients who always pay on time and never have nonpayment, then you have nothing to worry about, and you can earn the highest rate when it comes to getting paid a percentage. However, if your clients are untrustworthy and have multiple nonpayments regarding your business, you may have to fork over a higher factoring fee.
The factoring fee is the percentage of the receivables being factored, meaning it is the total amount of money paid to the company. The rate charged by the receivables factoring company depends on various factors, such as the industry, the volume of receivables, the creditworthiness of the clients, and the average days outstanding in payments.
Furthermore, you may also find the receivable factoring rate depends on the type of factoring – recourse factoring vs. non-recourse factoring. Factoring companies will usually have a lower interest rate for those businesses who use recourse factoring, as it means the company owner will be the one who has to pay for any non-payments on their invoices.
Therefore, if you are a new business that does not have excess capital, recourse funding is not the way to go. However, if you have trustworthy and creditworthy clients, recourse factoring is the best option for you.
For new businesses who have no extra working capital or cash flow, non-recourse factoring is the best bet. Non-recourse factoring is when the receivable factoring company is the one that pays any nonpayments on an invoice. Although this sounds like the best option, it often comes with a higher rate for the compensated risk of nonpayment.
Steps of receivable factoring
Now that you know the basics of account receivables and how the company does business, you need to know the steps of receivable factoring. The factoring company of your choosing will buy your customer invoices and provide you with a cash advance almost immediately. Sometimes, this cash advance is the same business day, and practically every business will offer you the cash advance by the end of the workweek.
The amount of cash advance you receive or your invoice depends on the aforementioned factors of your business, such as creditworthiness and length of the invoice, and will usually range between 75% and 95% depending on the company.
Keep in mind, when it comes to receivable factoring, the payment is not a loan. Although the process is similar to a professional bank loan, you do not have to worry about the after-effects, such as a lower credit score or inadvertently taking on more debt.
Here are the basic steps of how factoring receivables work in all industries:
- Step 1: you do business as usual and sell your products or services to your clients.
- Step 2: you invoice the customer as soon as the services or products are delivered or used, according to any agreed upon contract previously stated
- Step 3: you sell the factoring company your invoices/receivables to see if they will accept your invoice and pay you a cash advance. The invoice is then “purchased”, and you are provided an advance payment, usually between 75 and 95%, with the rest being in reserve to be paid later.
- Step 4: your customer pays their invoice, and the reserve money is then deposited into your account, minus the service fees kept by the factoring company.
The main takeaway to think about when using receivable factoring is that you get the bulk of the money owed to you by clients almost immediately. Instead of only getting a small percentage to pay for daily expenditures, you get the majority of the owed fees, those that you can continue to run the business, as usual, take on new clients, pay vendors, pay employees, and explore new opportunities.
Although you have to do some paperwork to use receivable factoring, the entire process is easy and simple, making it a smart choice for new business owners and startup companies.
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Using receivable factoring is a foolproof way to keep your new business afloat and financially stay in the green zone. Instead of dipping down into the negative red zone to pay your vendors, employees, and clients, you need to find a financial solution that won’t break the bank – which is factoring.
Factoring helps businesses in all industries obtain immediate cash flow so they can continue operations as usual. Along with paying daily operational costs, the rapid cash flow lets new businesses have enough working capital to pay their employees, pay vendors, explore new opportunities, invest in new facets of their company, and make intelligent business decisions.
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