In most cases, a business that needs an infusion of cash right away to help them get through a difficult time or to foster expansion will go to a bank for a loan. But if your customers are businesses as well, then you may want to think about factoring your accounts receivable instead.
Here is how it works:
- The purpose of this financing option is to free up your cash flow instead of having the money tied up in your accounts receivable. This method essentially “sells” your ARs to the factoring company, instead of getting a loan.
- Initially, the factor’s main concern is that your customers are creditworthy so that they know the invoices you issue will be paid in full on or before the due date. The factor’s research can be very helpful in helping you identify which among your customers can be trusted to pay promptly.
- Once your factoring set up has been finalized, you can send the factor a copy of the invoice. Usually, this invoice will specify the amount owed by the customer and also when the payment is due, usually in 30 days or 60 days.
- Instead of having to wait for that money, you can get a sizable percentage of the money immediately. It all depends on your agreement with the factor, but on average you can get about 80% of the value of the account receivable upfront.
- The remaining 20% will be sent to you once the customer pays in full. The factor takes over the management of your accounts receivable, and they do the collecting as well. The customer pays the factor directly, and then they pass on the rest of the payment to you after they have taken their fees.
- You can then use this money for any of the most pressing needs of your company. You can pay the salaries of your workers, cover the operating costs, pay your supplies, or improve your business by doing renovations or buying new equipment. Factors usually don’t care what you do with the cash advance, unlike banks who want to know what you wish to do with the loan proceeds.
- The factor doesn’t just advance you the money against the accounts receivable. They process your receivable as well. Essentially, it’s as if you are outsourcing your accounts receivable processing and collecting to a third party.
- In some situations, all accounts receivable may be part of the factoring arrangement. But it may also be possible to only choose certain invoices for factoring.
As you can see, it really is very simple. Factoring your accounts receivable is a much faster process and much more likely to get approved than getting a bank loan. And getting the funding you need does not affect your current credit, nor are you required to put up your personal assets as collateral.