Bank lenders have always been a temperamental lot, especially when it comes to lending money to small businesses. Almost 80% of all small business loan applications are rejected by the big banks. In smaller banks, the approval rate may be closer to 50%, but there aren’t really all that many small banks these days.
So what’s a small business to do? If your bank suddenly pulls your line of credit even if you pay your debts regularly and on time, you don’t have to lose sleep over it. You can still get the cash you need through account receivable factoring.
What is Account Receivable Factoring?
Account receivable financing and invoice factoring are technically two different methods of financing. Supposedly, account receivable financing is a type of loan, with the use of the ARs as collateral to secure the loan. In factoring, however, the money you get is part of an outright sale of the accounts receivable, so the money is not actually a loan per se.
However, many lending institutions these days use one term to mean another, so that can be confusing. But essentially the process is simple enough to grasp.
Let’s say you need a quick infusion of cash, so you approach a factoring service for the money you need. After all, you have accounts receivable which show that you have money arriving in 60 days or less from very reliable customers. These accounts receivable can be leveraged to get instant cash.
The factor investigates your customers and identifies them as good paying customers, which then justifies the risk of the financing. The factor then advances about 80% of the value of the invoice to you. However, some factors only offer 70% while others can go up to 90% of the value of the invoice.
You can then use that money to pay your utilities, meet your payroll, or buy inventory and raw materials for your business. When the customer finally pays up, you get the rest of the payment, after the factor has deducted its cash advance and the fees they charge.
Points to Consider
One of the most important points to consider when it comes to account receivable factoring is the precise details of the funding arrangement. You need to hammer down the details so there are no disagreements later on when hypothetical situations actually come up.
For example, what if a customer pays late? What if a customer refuses to pay at all? What’s the advance percentage you will actually receive? Who collects the fees from the customers? Which of your accounts receivable are eligible for factoring and financing?
You need to take down all these details, and then you should contact other factoring services to see if you can get a better offer. Factoring services can be very quick to set up, but you pay for the privilege with higher premiums. By shopping around, you may be able to lower the fees so you can keep more of the profits for your business.