Accounts Receivable Invoice Factoring

Accounts Receivable Invoice Factoring Basics

Since the financial meltdown of 2007, the options for financing a business have become scare – particularly for small businesses. With the limited availability of credit for businesses, several types of higher-cost financing options have increased in use. One of those options is the factoring of accounts receivable.

While accounts receivable invoice factoring is not a new financing option, it is one that many businesses have turned to in recent times for their short-term cash flow needs.

Some businesses receive payment for services rendered or products sold at the time of purchase. Many other businesses invoice their customers for products and services and then wait for payment. For some invoices, payment in full is due upon rendering of the invoice, but for other types of invoices, installment payments are made over a period of time. Receivables that are made up of this last type of invoice are prime candidates for factoring.

Accounts receivable are an asset, but they are not liquid, meaning that invoiced but uncollected funds cannot be used to finance the business. Waiting for receipts to come in adversely affects cash flow. Since business owners have their own bills to pay, so waiting for future payments isn’t ideal – particularly if the business is experiencing a short-term cash crunch.Accounts Receivable Invoice Factoring

In effect, the business is financing their customer’s purchases. Interest is being charged and collected for this financing, but the business will only realize the benefits of interest over time.

Accounts Receivable Invoice Factoring relieves businesses of this burden and also eliminates the need to monitor the timeliness of receipts and the collection efforts that follow to collect unpaid invoices.

How Factoring Accounts Receivable Works

The business owner submits a listing of clients to a invoice factoring company. Usually, the listing indicates the principle balances outstanding, the interest rate being charged, and the timeliness of the customer’s payments. The factor selects eligible accounts from this listing. The factor often eliminates the accounts of late paying customers from the listing, and returns a revised list to the merchant along with an offer.

The receivables balances are discounted by the factor, meaning that they offer to pay a percentage of the amount due to the merchant. The discount percentage varies, but is routinely much higher than the rates that banks charge for commercial loans.

Upon agreement, the factor remits approximately 80% of the agreed upon amount to the merchant and retains the remaining 20% for a “holding period” of a month or two. Once all of the customers have been notified of the change and they begin to remit payments to the factoring company, instead of to the merchant, the withheld amount is forwarded to the merchant to complete the Accounts Receivable Invoice Factoring process.

One can see why this is an attractive option for businesses carrying receivables for installment payments. It allows the merchant to have access to cash (although discounted), while transferring the burden of collecting the receivable balances to the factor.