Many businesses these days solve their cash flow problems through accounts receivable factoring. You get about 80% of the value of your invoice in advance, and then the rest of the money will be given to you when your customer pays in full.
There are several advantages to this approach: you have a better chance of getting the money you need and the entire process is very quick when compared to bank loan applications. But to maximize the benefits, you have to make sure that you get the best AR factoring terms.
As a business owner, you’ll probably be more concerned about how the AR factoring terms specify how much money you’ll get and how much you have to pay for the factoring service. All these are crucial, but there are several options in factoring which you have to consider.
Factoring isn’t a loan. Essentially, you sell your invoice at a discount to the factor so that you don’t have to wait for 90 days to get your money. Instead, you get your money right away.
But if the customer doesn’t pay the factor for any reason, then you’ll be required to pay back the money you received as an advance. This is called recourse factoring.
But if you want, you may avail non-recourse factoring if the factor offers it. In this type of factoring, factors absorb the loss of the advance money should the customer declare bankruptcy and default on the payment. However, this may mean that the advance you get may be smaller and the fees you pay can be greater.
In many factoring cases, every invoice is submitted to the factor who then chooses which invoices to advance money on. If one of your customers is notorious for nonpayment and the factor has agreed to a non-recourse factoring, then the factor may refuse to advance you the money for the account receivable.
But you may negotiate for a factoring service in which you choose which invoices to give to the factor. You can choose just enough of the invoices to generate an amount which should suffice for your needs. Your other invoices will then retain their full value and you won’t have to pay fees for having them processed by the factor.
In a way, this is like having a line of credit.
Many AR factoring terms lock you into a long-term agreement, but the duration may be too long for your business. You should only get the factoring service while you need it, and you can negotiate this with the factor.
This is why some agreements may enable you to choose when to end the factoring agreement, although factors can vary as to what kind of warning time they need. Some factors may ask that you give a year, while others may only ask for three months’ notice.
Factoring can help your business. By agreeing to the right AR factoring terms, you can make sure that everyone’s a winner.