Struggling to keep your business flush despite the fact that you have a steady stream of customers knocking at the door? Lacking cash flow even though your accounts receivable show that you’re running a profitable business? As difficult as it can be, it’s not a unique position. In fact, many small businesses and start-ups find themselves here. There is a solution, though. You can use accounts receivable factoring to shore up your finances, keep cash flowing through your business, and even achieve growth.
What Is Accounts Receivable Factoring?
If you’re not familiar with the term “accounts receivable factoring”, you probably know the process under another name. It’s also called business factoring, receivable factoring or invoice factoring. It’s one of the oldest financial tools available to business owners just like you, and has been around for literally thousands of years. So, how does the process work?
To get started, you only need an unpaid invoice from a customer. You take that invoice, and sell it to a factoring company. The factoring firm then pays you an advance against the total of the invoice, and you can use that money to pay your employees, invest in new equipment, purchase new stock or more supplies, invest in a second business location, or whatever else you need.
Once your customer pays the invoice, the factoring company remits the remainder of the balance to you (less the factoring fee, of course).
Sound simple? It is. However, there are a few things that you’ll need to know before embarking on the process. It’s not quite as easy as looking up a Canadian factoring firm through Google and jumping right in.
How Can Accounts Receivable Factoring Boost Business Growth?
As we mentioned, you can use the money from accounts receivable factoring for pretty much anything you need, whether that’s making payroll or taking advantage of a short-term business opportunity to grow your business. In fact, business growth is one of the most common reasons that owners just like you take advantage of the ability to factor their accounts receivable.
Let’s look at a brief scenario that can highlight just how you can use this process to benefit your company. Suppose you run a small manufacturing company – you design and sell an innovative garden watering system that reduces water waste.
You get a large contract from a DIY store chain. You manufacture and deliver the products. Now you wait for your customer to pay the invoice. It might be 30, 60 or 90 days before the company finally pays what they owe. During that time, you have money on the books, but not in hand.
Now, suppose a competing chain of DIY stores is interested in a similar order. However, because so much of your money is tied up in accounts receivable, you lack the funds to purchase raw materials and supplies to complete the new order. What happens?
Well, chances are good that if you can’t meet their needs, that new customer is going to turn elsewhere. That leaves you in the lurch. You can’t grow because your money is tied up – you’re waiting on the first customer to pay, before you can serve another large customer.
Enter accounts receivable factoring. With the right factoring partner, you can sell that first unpaid invoice and get the money you need to purchase materials to complete the second order. That doubles your profitability. And, should you choose to sell the second invoice to the factoring company, you could then go on to serve a third large customer, or multiple smaller customers.
You get the picture, right? Factoring gives you the agility to build your company, grow your wealth and cement your position.
What about Business Loans Instead of Accounts Receivable Factoring?
Think that you could accomplish the same thing with a business loan, or a merchant cash advance? You might be able to, but that’s a very flimsy presumption. In fact, chances are good that while you might eventually be able to secure the funds you need, the time required to get a loan from a bank would cause that second customer in our previous example to find a company that was better able to serve their needs.
There are quite a few differences between bank loans and factoring. One of the most important is speed. How long would it take to obtain a loan or line of credit from a bank? The usual process takes between a month and two months. What customer is going to wait that long for you just to start to fill their order? The answer: very few.
Now, compare the speed of accounts receivable factoring – you can generally have your money in hand in just 24 to 48 hours. That’s a serious difference, and it can have a massive impact on your ability to conduct business and grow your company.
There are other things that set factoring apart from bank loans. One of those is the fact that you’re selling an asset, not taking on more debt. This means that you’re not further degrading your business credit, and you have less liability. You already own the money represented in that invoice – it’s yours. Factoring doesn’t change that. You’re just getting an advance on the invoice that allows you to keep your business running.
How does factoring compare to a merchant cash advance? There are many, many differences here, despite the concepts sounding vaguely similar. A merchant cash advance, despite the name, is a loan. It’s made based on the number of receivables you have, but it’s generally based on credit card sales. Really, it’s a tool better geared to B2C companies than it is for B2B companies. And, because it’s a loan, it’s a form of debt, and you’ll find that most merchant cash advance companies go to great lengths to ensure that you repay that loan on time, including daily debits against your credit card sales. That doesn’t sound like a particularly good way to gain liquidity, does it?
Understanding the Accounts Receivable Factoring Process
We briefly outlined the factoring process already, but there’s more that you’ll want to know. For instance, how much can you expect to see in the advance? How much will you pay as a factoring fee?
When you sell your invoice to a factoring company, you’ll receive somewhere between 70 and 90% of the invoice total as an advance. The actual percentage varies widely between factoring companies, which means doing your due diligence prior to partnering with a company is essential. Once you receive the advance (generally within 24 to 48 hours), you can use it to fund business growth.
The factoring company now owns the invoice (and they’ll inform your customer of this, and collect on the invoice, too). When your customer pays the invoice, the factoring company will deduct their fee from the balance on the invoice, and then pay you the remainder. That’s the end of the process.
If you choose to work with a company that offers spot factoring (one-time invoice sales), your relationship is done. However, if you sign a long-term contract, you will sell each invoice from that client to the factoring company in exchange for an advance. Obviously, this may or may not be a good thing for your company, so you’ll need to consider the situation carefully before deciding on a particular factoring firm.
You’ll also need to consider other elements of the contract before signing on the dotted line. For instance, what other fees or charges are assessed in addition to the factoring fee? While some companies charge minimal amounts, and primarily make their profit in the factoring fees, others promise low fees, but then make up the difference in hidden charges. Often, this turns out to be more expensive for you.
We highly recommend vetting potential factoring companies. You need to compare their offers, including the percentage of the advance, any minimum requirements, the factoring fee, hidden fees and charges, their reputation and more. Interview each company, conduct a side by side comparison off their offerings and, if possible, speak with current or past clients about their experience.
Now, with all that being said, there are some potential downsides to accounts receivable factoring. One of the most obvious is that it is, ultimately, more expensive than getting a loan through a bank. The factoring fees charged are generally more than what you’d pay in interest with a bank loan. However, the speed with which you gain access to your money, and the fact that you’re not taking on new debt make this a more attractive option for most business owners.
There’s also the fact that you will never recoup 100% of the invoice total. That means you’re leaving some cash on the table with every invoice you factor (that cash makes up the profit for the factoring company). Only you can determine if the benefits of factoring outweigh the potential drawbacks.
Then there’s the fact that if your customers aren’t particularly creditworthy (they pay very slowly, or have a history of missed payments entirely), you might have a hard time finding a factoring company to work with you. This is understandable – if your customers don’t have a stable credit history, the factoring company would be taking a huge risk in working with you. While some factoring companies might be willing to take that risk, you’ll see higher fees being charged.
Finally, as we mentioned, factoring companies will alert your clients to the fact that you’ve sold the invoice. This is normal, but it might alarm some customers. There’s a misperception out there (based on a myth) that factoring invoices is an indication that your company is having money trouble. While there’s nothing further from the truth, that misperception persists with some customers.
Are You a Good Fit for Accounts Receivable Factoring?
As beneficial as accounts receivable factoring is, the fact remains that it’s not a good option for all businesses. If you have customers with spotty credit histories, or you only have a handful of low-value invoices, you might not be a good fit. If your invoices are not net 30, net 60 or net 90 days, then you also may not be a good fit for this process. Finally, if you’re a B2C company rather than a B2B company, then you will probably struggle to find a factoring company that will work with you.
Then there’s the question of your industry. Certain industries are better suited to factoring than are others, but it’s important that you work with a factoring firm that specialises in your particular niche. For instance, manufacturing companies, trucking companies, staffing companies, gas/oil companies, distributors, construction firms, landscaping companies and others are generally very well suited to factoring, and will find specialist firms waiting to help them.
Ready to Get Started?
Accounts receivable factoring can be highly beneficial for your business, allowing you to access capital that’s locked up in unpaid invoices and grow your business without the hassles of getting a loan or line of credit from a bank. However, it’s not a simple area to navigate. There are factoring companies out there that are well worth your time, but some should be avoided.
Likewise, there are specialist firms and generalists, and they may or may not fit your needs. We invite you to take advantage of our free consultation with one of our factoring specialists and learn how we can help you navigate these murky waters.