Accounts Receivable Financing / Factoring

by Brandon Cornett

Summary: What is accounts receivable financing and how do small business owners benefit from it? What types of businesses can use this financing method? These are the questions we will answer in this article.

Accounts receivable financing (also commonly referrered to as factoring or A/R financing) is the process of selling your current invoices / accounts receivable to a bank or finance company. The companies who provide this service are commonly referred to as "factors." The Factor will advance a percentage of the invoice(s), usually 80%, from a line of credit they have established for your company.

The advance usually comes in the form of a wire transfer directly to your bank account, once the factor has completed a review and verification of the invoices. Your customer(s) will then send payment of those invoices directly to your accounts receivable financing company / factor, rather than mailing the check to you.

The factor will collect their fee from the 20% held at advance, and will rebate the remainder to you within the pre-established number of days in your contract. Some accounts receivable financing companies will collect a flat fee up front when they advance your funds, while others will base the fee on the number of days the invoice is outstanding (and collecting it when the invoice is paid in full).

While the fees for this type of small business finance may be higher than a traditional line of credit, it is a great option for small businesses who are just starting out. Accounts receivable financing can also be useful for companies with less-than-great credit, as well as those with a history of losses that would prevent them from obtaining traditional financing.

Other Benefits of A/R Financing

A/R financing also provides small business owners with a definitive means of repaying their debt. The amount of credit is generally based on the average amount of outstanding accounts receivable, which means there should always be enough collateral to cover the debt to the factor. The fees for A/R financing are based on the credit of the principals / owners and the prior financial performance of the company and accounts receivable.

For the small business owner, the primary benefit of accounts receivable financing / factoring is simple. Rather than waiting the 30, 60 or even 90+ days for their customers to pay them, they have immediate access to the necessary cash flow to cover bills, payroll and purchase of additional inventory.

Many factors will also monitor your accounts receivable and help with the collection of these invoices, which means your staff is freed up to perform other essential tasks. If your fee is based on number of days an invoice is outstanding, this will also help you save money because your invoices will often be paid sooner with the added collection efforts by your Factor.

I hope this brief overview of accounts receivable factoring gives you a better idea how this financing tools works,and I wish you success in all of your business ventures.