Shortening Payment Time with Accounts Receivable Factoring
In my last post, I talked about the nightmares managing accounts receivables can bring you. Today, I want to talk solutions, specifically accounts receivable factoring and how it can shorten the time between services rendered and payments received.
I used the trucking industry as an example last time I talked about accounts receivable. I use it again this time. It’s not uncommon for a trucking company to render services and receive payment far into the future, sometimes 3-6 months. Even though the trucking company waits for payment (accounts receivable), the trucking company still has expenses which need to be paid on time. Furthermore, carrying accounts receivables carry the risk of not getting paid.
Utilizing an accounts receivable company can help companies get paid for their work in a more timely manner while also reducing their risks of not getting paid for services.
What is factoring?
Factoring is a way to sell your accounts receivables to another organization (aka factor) at a discount. Factoring comes with pros and cons. The big pro is you get paid right away. As a result, you’ll have money to meet your working capital needs. Factoring also takes the stress/workload off your business in trying to collect from clients/customers.
As for the cons… well, you won’t get paid the full amount for the services you render. In general, you can expect to see a 2-7% discount rate depending on the company and the aging of the receivables. You likely won’t receive the total amount due upfront from the factoring company either. Instead, they’ll likely pay you 80-95% of the total payment due you upfront. Then you’ll receive the balance one your client/customer pays their account. In most cases, if the client/customer does not satisfy the bill, you are responsible for the debt and your debt may be reclassified as a loan.
How to choose? How to choose?
There are hundreds of factoring firms available to choose from. So making the bet decision for your company can be a tough one. Fear not. I have some thoughts to consider before committing.
- Does the company specialize in your company’s industry? The last thing you want is to deal with a factoring company that doesn’t know the ins and outs of your trade. The factoring company should know the industry standard for accounts receivables, such as the turnover rate.
- What’s their customer history? You don’t want to end up with a fly-by-night business. Be sure they’re members of the International Factoring Association (IFA). In order for a factoring company to join the IFA, the factor must commit to the rules and regulations of the IFA, which includes ethical codes.
- How much flexibility do they offer? For example, you may not want to sell all your invoices to the factor. Some clients you may have strong relationships and they pay on a timely manner. It might not make sense for you to share 2-7% of the profit with a factoring company in that case. The factor might even have a personal guarantee clause, making you personally responsible for the invoice until paid by the client. Read the contract thoroughly before you sign on the dotted line to prevent any surprises down the road.
- What is their pricing schedule? Factoring rates can vary by aging, volume of invoices per month, average amount of invoice, and even the length of time you’re in contract with the factor. It’s important to understand their rates so you can properly manage your cash flow. Also look for hidden fees and additional expenses. Factors also take on a certain amount of risk, so they’ll want to know your customers are credit worthy. This might involve passing the fees for credit reports to you.
- How is their customer service? If you have questions, you’ll want immediate answers. Not getting those questions answered in a timely manner can result in lost time and money for your business. Pay special note to the turnaround it take for you to get your questions answered before you commit. Try contacting them both by phone and email. You might even ask for references.
Factoring can be beneficial, particularly for a company just starting out and in need of capital to cash flow their company while waiting on payments.
What has been your experience with factoring?