Accounts Receivable Financing and Factoring: How it Helps Small Biz Cash Flow

Say you’re strapped for cash. You don’t exactly need a small business loan, nor do you have the time to go through the application process. Although you are expecting several invoices to be paid by large clients in the upcoming weeks or months, you need money now to pay your employees and vendors.  What’s the solution?

Accounts receivable financing or factoring might be an option for you — depending on your industry and the nature of your business.

What is Accounts Receivable Financing?

Accounts receivable financing involves borrowing against your receivables or selling your receivables to a company that will pay you an amount equivalent to the invoice amount due you, less a discount.  The amount of  the discount varies depending on the size of the transaction, the extent of risk that the financing company (sometimes called a “factor”) has to take to collect the amount due, and other matters.  You’d get more for an invoice payable by a blue chip company that’s due soon versus one that’s, say, 90 days past due from a weaker payor.

Factoring has been around at least 500 years, says Dan Casey of AccountsReceivableFinancing.com.  He notes that it  involves the:

“… process of selling your rights to collect an invoice.  The factor/invoice buyer pays a high percentage of the invoice face value day one.  Upon collection, the factor funds the balance of the invoice value less their fees for service. “

Here is a breakdown of different accounts-receivable financing types:

Accounts Receivable Financing and Factoring cheat sheet

So with these types of services, you can either borrow against the money you expect to come in soon, or sell the invoice itself at a discount.  The net effect in either case is that you get a lot of money a lot sooner.  You can see other benefits and drawbacks in the chart above.

Benefits of Accounts Receivable Financing

The primary benefit to these financing services is to help small businesses get cash quickly.

It’s particularly useful for businesses that get paid large invoices by clients that may pay slow for one reason or another (such as large corporate clients, or when part of a large multi-phase government contract).  Yet, in the interim that small business still has a payroll to meet — putting the business in a cash flow bind.

Accounts receivable financing can also help free up working capital. Because so many businesses have funds tied up in inventory, getting paid for invoices quickly is paramount.  Getting financing takes that worry out of the equation for small businesses.

Factoring, where you actually sell the invoice outright and the factor takes over collection, can take away the headache of chasing down payments from clients. That alone can save a small business time and money in the form of internal staff resources dedicated to follow-up and collection.

What Accounts Receivable Financing and Factoring Costs

Just like any other type of financing or loan, you will pay for the privilege of getting access to cash quickly. Casey says at his company, invoice financing fees can vary from 1% to 3% per month. The rate you’ll pay depends on the size of the transaction, your monthly dollar volume and your credit worthiness. The fees will also depend on whether you’re getting factoring financing or accounts receivable financing.

Is It Right for Your Business?

Accounts receivable financing companies often specialize in a particular industry or type of transaction, e.g., staffing services industries or government contracts.  When looking for such financing, check their website or ask if they handle transactions in your industry or of your type.

Consider your reasons for needing quick financing. Is it a temporary problem?  If not, it might be indicative of something bigger that needs to be addressed.  Accounts receivable financing is not designed to buy time to hold off the inevitable.

How much are you willing to pay for the privilege of getting access to money faster?  In essence, accounts receivable financing is like dropping your prices.  On the other hand, it might be well worth it if it keeps your cash flow steady and uninterrupted — the alternatives (drawing on expensive credit cards or incurring late charges) could be more expensive.  You really have to look at the big picture and the full impact.  Speak to your accountant to understand the overall financial impact on your company.

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Susan Payton - Awards Communication Mgr.


Susan Payton Susan Payton is the Communications Manager for the Small Business Trends Awards programs. She is the President of Egg Marketing & Communications, an Internet marketing firm specializing in content marketing, social media management and press releases. She is also the Founder of How to Create a Press Release, a free resource for business owners who want to generate their own PR.

13 Reactions

  1. Susan: Do you know how big accounts receivable financing is in the United States?

    • Martin–
      I’d never heard of it before writing this, but that doesn’t mean much. I feel like it’s starting to get more attention now.

      Susan

    • Hi Martin — It’s growing. There is even a trade association, called the International Factoring Association.

      A challenge that most small businesses have with factoring and accounts receivable financing is that often factors/financing companies stick to highly specialized areas. They only accept certain types of deals in certain industries. It’s difficult for small businesses to know which companies are right for their industry. I suspect there’s a lot of wasted time and effort on both sides (factors and small businesses) when small businesses inquire about situations where the factor can’t help them.

      That’s why it’s so important that factors specify clearly on their websites which types of industries or business types they accept deals in. And small businesses should examine the site carefully to see whether the finance company/factor looks like a fit.

      - Anita

      • Anita: Thanks for the link to the trade association. I will check it out. It will be interesting to follow the development of this type of financial service. A sound cash flow is one of the most important success factors in running a business. I think that the accounts receivable financing could be a good solution if you pick a vendor that fits your type of business.

    • Accounts receivable financing is a multi-billion dollar financial product in the US used by small businesses to the Fortune 500. Cashflow is the life blood of small business. A significant benefit is creating a smooth, predictable checkbook as well as having a life raft during cash challenged times.

  2. Accounts receivable financing makes sense in certain situations and can certainly be a life saver at times. I’ve seen a couple solid businesses get strap for cash while waiting for some large pending receivables, and they gave up some ownership to some investors to help with the cash flow problem when they should have just done some sort of account receivable financing.

  3. Before you apply and be successful in receiving any kind of financing or factoring it’s important to prepare a cash flow projection and explain just how you plan to use the funds you are receiving. Your cash flow projection should also detail how the funds will be paid back. It’s important to have this plan in place. I have detailed information on setting up a cash flow projection at http://www.smartbusinesscashflow.com.

  4. Accounts receivable financing or factoring might be an option for you depending on your industry and the nature of your business.Accounts receivable financing involves borrowing against your receivables or selling your receivables to a company that will pay you an amount equivalent to the invoice amount due you, less a discount.

  5. hello, please i need a legal article on Receivable Financing in Canada or Australia,working on a dissertation that requires me to do a comparative analysis. please i will be grateful

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