It can be very challenging for small business owners to keep cash flowing through their companies. If you’re stuck waiting on a client to pay an invoice for 30, 60 or 90 days, it can create serious problems for your business. That’s why you may explore accounts receivable funding to help solve potential cash flow issues.
What do you do while you’re waiting for your client to pay what they owe? How do you pay your own bills, make payroll or purchase supplies and materials for the next job? All too often, the answer is that you wait and suffer. It doesn’t have to be that way.
Accounts receivable funding can provide you with the cash flow you need, without running your business deeper into debt. Of course, you’ll need to know what accounts receivable funding is, how it works, and how to make the best use of this financial tool.
We’ll start with a discussion of what it is and move on from there.
What Is Accounts Receivable Funding?
If you’re not familiar with the term “accounts receivable funding”, you might be more familiar with this financial tool under another name. It’s also called invoice factoring, accounts receivable factoring, and receivables factoring. It has been around for a very long time. In fact, it’s one of the oldest financial tools in the world.
While most types of commercial financing rely on debt – you take out a loan, for instance – accounts receivable funding relies on the sale of an asset in order to unlock capital and give your business an infusion of cash. In this scenario, rather than selling unused equipment or surplus materials, you’re selling an invoice.
That invoice is purchased by a factoring company, which gives you an advance on the invoice total. When your client pays the invoice, the factoring company gives you the remainder of the invoice total, less a fee that you will agree to in the beginning.
Now that you know a bit more about what accounts receivable funding is, let’s take a look at how the process actually works.
Understanding How Accounts Receivable Funding Works
Accounts receivable funding is simple and straightforward, unlike most financial tools available to small business owners. All it really requires is an invoice with a due date 30, 60 or 90 days from now. Rather than waiting for your client to pay that invoice, and suffering the cash flow problems that inevitably go hand-in-hand with term payments, you sell it to a factoring company.
The factoring company will offer you an advance on the invoice total. This is usually between 70% and 90% of the invoice’s face value, but some factoring companies will offer more. Once you agree to the sale and sign the contract, your money will be available within 24 to 48 hours.
Once you have your money in hand, you can use it for anything that your business might need. Some of the most common uses include the following:
- Purchasing supplies
- Purchasing materials
- Paying your own bills
- Marketing and advertising
After you’ve signed the contract, the factoring company owns the invoice. This means that your client will not be paying you – they’ll pay the amount due to the factoring company. When that happens, the factoring company will give you the remainder of the invoice amount, minus the factoring fee, which is usually between 1% and 5% of the invoice’s value.
As you can see, there’s a compelling case for using accounts receivable funding to help bolster cash flow within your business. In the next section, we’ll take a look at some of the most important advantages offered by this financial tool.
Understanding the Advantages of Accounts Receivable Funding
Taking advantage of a factoring company’s services can offer you quite a few important advantages that allow you to grow your business and enjoy financial stability. We’ll touch on some of the most important below.
Speed: For B2B companies, the most pressing problem is maintaining steady cash flow through the business when clients have 30, 60 or 90 days to pay their bills. While those terms might be standard today, they’re not beneficial for the company waiting on the payment.
With accounts receivable funding, you’re able to get the cash you need, immediately. It’s also faster than obtaining a bank loan, which can often take up to two months for approval. In most instances, a factoring company will pay you within 24 to 48 hours.
No New Debt: With most types of commercial financing, boosting cash flow in your business requires that you take on new debt. You might think about offsetting your money problems by getting a loan from the bank, or taking out a line of credit. Both of those create new debt, and require that you repay the money over time.
While you might benefit from the initial infusion of cash, you’ll eventually be in a worse situation than you are now. Factoring is based on money that you already own; it’s just not available to you yet. So, you’re not creating new debt but instead unlocking your own capital.
Not Tied to Your Credit: Lenders have tightened their criteria significantly, and business owners with less than perfect credit will find it very difficult to obtain a conventional loan. One of the benefits of accounts receivable funding is that it is not tied to your credit in any way.
In fact, the factoring company won’t even look at your credit history or financial situation. Their focus will be on your client’s creditworthiness, instead. This means that businesses with poor or no credit can still improve their financial situation.
Eliminate Long Billing Cycles: Long billing cycles can be detrimental to your company, particularly when you’re small and growing. Waiting a month, two months or even three months for a client to pay an invoice could mean that you’re unable to take on a new project because you lack the funds to purchase materials and supplies, or to pay for the labor involved.
By working with a factoring company, you can eliminate long billing cycles and free your company for growth. Accounts receivable funding ensures that you have the money that you’re owed almost immediately, allowing you to move on to the next client and the next project without waiting.
Overall, accounts receivable funding provides a crucial financial tool for small, growing companies. However, you do need to know a few things before partnering with a factoring company. We’ll discuss those in the next section.
Considerations When Working with a Factoring Company
Factoring companies come in all shapes and sizes. Some are worth your time, but others should be avoided. Part of your due diligence when comparing factoring companies is to know how they can vary in their terms and conditions, and how they operate. Let’s take a look at some of the things you’ll need to know.
The Factoring Fee
As mentioned, you’ll have to pay a factoring fee to the company offering accounts receivable funding. Usually, this is between 1% and 5% of the invoice total. However, some companies charge higher fees. The more you pay in fees, the less money you’ll have overall. Look for a company that charges a reasonable factoring fee and provides you with a large advance to make sure that you’re able to realise the full benefits of invoice factoring.
With some factoring companies, you might be charged other fees beyond the factoring fee. These can vary greatly from one firm to another, but they should be spelled out in the contract. Make sure to read your contract thoroughly an ask questions about anything that is unclear.
Look at the fine print for additional charges and potential hidden fees that will eat into your cash. Ideally, the factoring company should be upfront and transparent about all the fees and charges that will be assessed.
The Term of the Invoice
The factoring fee will be assessed when your client pays the invoice, but you might be charged more than once. This is determined by the term of the invoice – how long your client waits to pay. Most factoring companies charge a factoring fee on a monthly basis.
So, if you sell an invoice with 90 days remaining on it, and your client takes the full 90 days to pay, you’ll be charged the factoring fee not once, but three times. Some companies assess the fee weekly, as well. So, if you sold an invoice worth $10,000, were charged at 1% per week, and the invoice was for 30 days, you would ultimately pay $400 in factoring fees.
Can You Afford It?
Make no mistake – accounts receivable funding is ultimately more expensive than taking out a bank loan. And, while it does not create new debt, it does mean that you will not see 100% of the profit from your client. For some small businesses, this may not work. If your profit margins are so tight that you cannot survive without receiving 100% of what your client owes you, then factoring may not be the right path for your business.
Do You Trust Your Client?
The most common type of factoring in Canada is recourse factoring. What this means is that if your client does not pay the invoice, you’ll be required to repay the advance to the factoring company. So, it makes sense that you should only sell invoices for clients that you fully trust to pay their bill (and to pay it by the due date of the invoice). If you have any questions concerning your client’s ability to pay on time, don’t sell the invoice.
Some factoring companies offer nonrecourse factoring, though. In this situation, you’re not liable for repayment of the advance if your client doesn’t pay. The factoring company takes on full responsibility here. However, the fees are usually higher because the factoring firm is taking on higher risk.
The key to benefiting from accounts receivable funding is finding the right factoring company for your needs. You’ll need to vet potential candidates based on specific criteria, which will discuss next.
Finding a Factoring Company to Take Advantage of Accounts Receivable Funding
There are many factoring companies in Canada. Some are well worth your time, while others really should be avoided. However, it can be difficult to tell the difference, particularly if this is your first experience with accounts receivable funding.
You’ll need to compare your options before choosing a funding partner. Look at the company’s length of history, their reputation in the industry, their fee structure and the length of the contract that you’re required to sign.
You’ll also need to check into their customer feedback – what do current and past clients have to say about their experience with the factoring company? Does the factoring company specialise in your industry? If not, how much experience do they have working with businesses like yours?
Ideally, you’ll choose a factoring company that has more than just passing familiarity with your industry. In fact, it’s very important that the company is very knowledgeable about your industry, as this will affect your overall experience, the quality of the service you receive, and even the fees that you’re charged in the factoring process.
Finding a factoring company can be a time-consuming, frustrating process. It requires that you invest time and energy that would be better spent growing your business. If you find yourself in this situation, we can help.
We have years of experience in helping our clients connect with the right factoring company for their specific needs and requirements in order to boost their cash flow and foster business growth. We invite you to take advantage of the free consultation with one of our factoring specialists. Contact us today to learn how simple accounts receivable funding can really be.