Mike, a small commercial painting/drywall contractor, found himself in a tight spot. Despite completing projects on time and maintaining a good reputation with his clients, he struggled to make payroll due to the extended client payment terms. When researching his options he had heard about accounts receivable factoring but was unclear what it was and how it would help him through his cash flow gaps. If you are also wanting to learn about this financing solution and its benefits, this article is for you.
– What is Accounts Receivable Factoring?
– Is Accounts Receivable Factoring a Loan?
– Is Factoring Receivables a Good Idea?
– What is an AF Factoring Company?
– What is Accounts Receivable Financing?
– AR Factoring vs. AR Financing
– Which is Right for Your Business?
What is Accounts Receivable Factoring?
Accounts receivable factoring (or AR factoring for short) involves selling an outstanding invoice or invoices to a third-party company – an AR Factoring company.
After they purchase your invoice(s), the Factoring company will advance you a percentage of the invoice amount, typically from 70% to 90%. This advance can happen as little as 24 hours after the Accounts Receivable Factoring agreement is approved. When they receive the final payment from your client, the Factoring company will return the remaining 10% to 30% to you, less their fees. These fees vary by industry and company but will be clearly spelled out in the Factoring agreement.
Is Accounts Receivable Factoring a Loan?
Because the factoring company has purchased your outstanding invoices, Accounts Receivable factoring is not a loan.
Is Factoring Receivables a Good Idea?
When you understand all the pros and cons, you will see that factoring can be a viable option, especially for businesses that need quick access to funds but have limited credit history.
It’s essential to understand that this financing solution isn’t only for businesses experiencing financial shortfalls. It can be a strategic choice to ensure steady cash flow during times of growth.
>> RELATED READING: The Pros and Cons of Factoring — Extensive List
What is an Accounts Receivable Factoring Company?
Because AR Factoring is a unique financial product, you will be working with a unique company. These companies are not typically banks, though it is not unheard of. Banks are typically highly risk-averse so they don’t like to offer financing to businesses they deem “risky” like construction, trucking, or staffing. This is where Accounts Receivable factoring companies take up the slack. Not only do they work with these industries, they might even focus on specific trades offering industry-specific benefits. Working with a factoring company that understands typical payment schedules, lien compliance, and other risk management, for example, can mean a much smoother, realistic working relationship. The last thing you want is to have even more stress working with a factoring company that just doesn’t understand the issues you are dealing with.
AR Financing? What is it and how it is related to AR Factoring?
Accounts Receivable Financing is similar to a traditional loan that allows a business to borrow money using the value of an outstanding invoice(s) as collateral. After the client pays the invoice, you pay the AR Financing company back.
The typical fees charged are 1% to 5% of the invoice amount. The percentage rates are often tied to how much time you need before repaying the AR Financing company, your credit history, and the amount needing to be funded.
Keep in mind that you might hear the term Accounts Receivable Financing used in two different ways. There is the Accounts Receivable Financing discussed above, but you might also hear: “accounts receivable financing” — a generic usage for any form of financing that involves accounts receivables or invoices.
How They Compare: AR Factoring vs. AR Financing?
Both options have their merits depending on your company’s situation. If you have good credit and the time to be approved, AR Financing might be the way to go. However, if you need funds quickly and have a limited (or no) credit history, AF Factoring would be the better choice.
Pros and Cons of Accounts Receivable Factoring
- Pros: Much faster application/approval time, your client’s credit rating is used so often easier to get, keep your extended payment terms with clients, offer additional industry-related services.
- Cons: Higher interest rates, the factoring company might communicate directly with your client about payment.
Pros and Cons of Accounts Receivable Financing
- Pros: Lower interest rates than factoring, you retain control of your invoices.
- Cons: Like with most loans, financing can be slow to get, you will need an established credit history, the responsibility of collecting payment remains with you.
So, Which is Best for Your Business?
Now that you understand the difference between both AR Financing and AR Factoring, one option should stand out as “the one”. If you believe factoring is the right option for your business, you will need to know how to compare factoring companies. The easiest would be to check out our guide entitled: How to Pick the Best Factoring Company.
If you’re convinced that CapitalPlus, with its 25 years of experience supplying AR factoring to the construction industry, is right for you, give us a call (or schedule a call) to get started.Back to blog