Accounts Receivable Factoring: How It Works, How Much It Costs
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Accounts receivable factoring is a way of financing your business by selling unpaid invoices for cash advances. A factoring company pays you a large percentage of the outstanding invoice amount, follows up with your customer for payment, then pays you the remainder of what you’re owed, minus fees.
This method — also known as invoice factoring or factoring receivables — can be expensive. But it can make sense to bridge cash-flow gaps. And because receivables factoring isn’t technically a small-business loan, it can be a good option for business owners with bad credit or short credit histories who may not qualify with a traditional lender.
How Much Do You Need?
How much does accounts receivable factoring cost?
Factoring companies usually charge variable rates. The longer your customers take to pay the invoice, the more you’ll owe.
For example, say a factoring company charges 2% of the value of an invoice per month. The invoice is for $50,000 of work.
If your customer pays within the first month, the factoring company will charge you 2% of the value, or $1,000. If it takes your customer three months to pay, the factoring company will charge 6% of the value, or $3,000.
Some factors charge weekly rates instead of monthly ones. For instance, if a factoring company charges 1% per week and your client takes four weeks to pay, you’ll owe 4%.
If your customer doesn’t pay, you’ll be on the hook if you’ve agreed to recourse factoring. Nonrecourse factoring means that the factoring company accepts those potential losses. Nonrecourse factors generally come with higher costs because the factoring company assumes more risk.
How does accounts receivable factoring work?
First, factoring companies typically pay most of the value of the invoice in advance. Advance amounts vary depending on the industry, but can be as much or more than 90%.
Next, your customer pays the factoring company the full value of the invoice.
Finally, the factoring company pays you whatever remains between the amount you were advanced and the full invoice amount minus fees.
For example, say you were advanced 90% of the value of your original invoice. You agreed to pay 2% per month and your customer took two months to pay, making your fees 4% of the value of the invoice. After your customer’s payment, the factoring company will pay you the remaining 6% of the value of the invoice.
Will you qualify for accounts receivable factoring?
To qualify for accounts receivable factoring services, business owners need to have established invoicing practices that give details about sales, prices and payment timelines. Invoices need to be for completed work, not work in progress. Customers also need to be other businesses or government agencies, not individual buyers.
Factoring companies may require businesses to have been in business for a certain amount of time and have a minimum amount of monthly or annual revenue.
The owner’s credit score doesn’t determine creditworthiness in accounts receivable factoring, however. Since lenders earn money by recouping payment from businesses’ customers, not businesses themselves, factors focus on the creditworthiness of those customers instead. This can make factoring a good option for businesses with bad credit or startups with short credit histories.
How is this different from accounts receivable financing?
Accounts receivable factoring is not the same as accounts receivable financing, despite their similar names.
Accounts receivable financing (also called invoice financing) is a type of loan that uses unpaid invoices as collateral. Business owners receive financing based on the value of their accounts receivable. After invoices are paid, businesses pay lenders back, with fees.
Factoring is typically more expensive than financing since the factoring company takes responsibility for collecting on the invoice. In the case of nonrecourse factoring, they also accept the losses if the invoice goes unpaid.
With accounts receivable financing, on the other hand, business owners retain all those responsibilities.
How do I find an accounts receivable factoring company?
Some small-business lenders offer receivables factoring, including online lenders like FundThrough. There are also lots of established players that specialize in certain geographies or industries — for example, factoring companies for trucking.
Factoring costs can vary significantly, so reach out to multiple companies for a quote. After approval, many factoring companies can provide financing within a matter of days.
Once you develop a relationship with a factoring company, you can return to them again and again. However, the factor will evaluate each of your customers for creditworthiness before deciding whether to factor those invoices.
