Receivables Factoring: An Easy Way to Free Up Cash from Unpaid Invoices
If you’ve been in business for any length of time, chances are you have a pile of unpaid invoices that are taking up valuable space and time. By using receivables factoring, you can free up the cash from those invoices to use for other purposes.
In this post we’ll take a look at what receivables factoring is and how it can benefit your business. You’ll also find out how to determine if it’s right for your company and get started with the process...
So, what is receivables factoring and how does it work?
Receivables factoring simply means that a company (factor) purchases the right to collect unpaid invoices from the original company (debtor) at preset interest rates.
The factor pays for the right using invoice factors (or sometimes called "cash factors" or simply "factors"). The invoice will specify a fixed amount of money as well as a minimum term, and can cover both payment terms and credit terms. For example, an invoice might be contingent on receiving an additional payment within X months after payment in full has been received.
The factor then takes over the responsibility of collecting on the invoice, sending notices and pursuing delinquent payors by various means. At the end of the term, the factoring company pays 95% to 97% of what it collects from the buyer to the business. The business also has to pay a small amount for administrative costs, which are often related to checks that need to be mailed or delivery services that need to be used.
Once all accounts receivable have been sold, a business can use those funds for any purpose—to expand their business, make payrolls or loans, cover operating expenses or even just pocket it as profit.
Factoring is a quick, easy and effective way to increase cash flow in your business. It can also reduce the amount of time your staff spends on collection attempts, freeing them up to work on other tasks that will help grow your business.
How can you use factoring to improve your business?
First, it's important to understand that factoring is NOT borrowing money. In fact, it's just the opposite: You're selling off one of your assets—your invoices—in exchange for an immediate influx of cash. With no loan fees and no interest charges, this can be a great way to get instant working capital.
Giving your people more time to do what they do best can be a major win for your business. Imagine, for example, that you're an architect. Right now your staff spends lots of time on the phone calling clients and chasing down payments. With factoring, you don't have to generate this work yourself, which makes the process much easier and less time-consuming for everyone involved (including you!).
Factoring can also be a great way to pay down some of your debt—in our example above, it might make sense in this instance to lighten the balance on credit cards rather than just paying off the principle.
Why should you choose receivables factoring for your business?
Factoring can be a great way to free up working capital while reducing the administrative burdens of tracking and collecting payment. With no out-of-pocket expenses, there's little risk involved as well.
Of course, every business is different, so you'll need to examine your situation before deciding if factoring is right for you:
How fast do your invoices get paid? This is not the most important factor in determining whether or not you can use invoice financing, but it's certainly a major one. If your clients pay their invoices on time, you might not find factoring very useful.
If, on the other hand, it takes you weeks to get paid after providing goods or services to clients, then factoring may be a great solution for you. It can help you get money quickly from some of your best customers (your past due accounts) so that you don't have to keep tying up working capital on those projects.
Do you have a healthy cash flow? If so, factoring could be worth looking into because it would allow your business to tap into one of its most valuable assets—its outstanding invoices—without having to invest in new inventory or technology.
Are you receiving a large volume of invoices? If so, you may want to consider doing something other than "selling" them for cash. Invoice factoring is great if your receivables have at least a 20% collection rate or better. This means that 20% or more of all invoices are paid on time, and you can use invoice factoring to collect on the invoices that are currently not paid.
Do you have a history of collections? You'll need to be able to demonstrate that your bill collection methods work for your industry before using factoring as part of your business model. In other words, if you're not able to collect your past due invoices through traditional methods, then it may not be a good choice for you.
How much do the administrative fees cost? Those fees are only going to be imposed if you try and collect on the invoices yourself. If you have an easy time collecting the invoices, then those costs will just be eaten up by the amount of money you earn from factoring. So if you need help collecting on those accounts, factorizing them may not be right for your business.
How much do the administrative costs represent of your total operation? Factorizing is a great way to make a quick infusion of cash for your business, but you'll want to find out if it's worth the bloated overhead that comes with it. Knowing this number can help you determine if factoring is right for your company.
Factoring is a great option for many companies, but not all businesses are candidates for using it.
Conclusion
Factoring is a fantastic option for your company if you have healthy cash flow and are able to demonstrate that the process works for your industry. If your receivable collection rates aren't very high, you won't be able to factorize your invoices at all.
You should also consider factoring if you're a SaaS or web-based business because those companies typically times tend to sell their invoices on a monthly basis anyway—so the sales pitch from the factoring company probably won't even be necessary. Instead, the terms of factoring could just make more sense.