Accounts receivable financing can be an effective way for companies to improve their cash flow. Instead of waiting for clients to pay for services rendered, a factoring company will buy the receivables for a significant portion of what they are worth. As with any type of financing option, it is important to know as much as possible about factoring before deciding if it’s right for your company.
It’s Technically an Advance
Accounts receivable financing is technically an advance on payments made by clients. Therefore, these types of transactions are generally not covered by state or federal lending laws. Furthermore, you generally don’t need to go through a credit check because the transaction is secured by the value of your outstanding accounts receivable.
Your Company Won’t Get the Full Value of the Outstanding Invoices
Expect to pay a fee of 5 to 25 percent when working with a factoring company. Therefore, if the invoices that are being purchased are worth $10,000, expected to about $8,500 when the transaction is complete. Factoring companies may also charge processing or origination fees as part of the deal.
The Company May Have to Enter Into a Long-Term Deal
While this is not always true, some accounts receivable financing companies will require you to sell invoices both now and into the future. In some cases, you will have to sell a certain number of invoices per month. In others, you will have to sell a certain dollar amount to get the advance.
What Happens If Your Client Doesn’t Pay?
After the invoice is purchased, your client is now responsible for paying the factoring company. If the client doesn’t pay, there is a chance that the factoring company can come after your business to get its money back. Typically, the client is subject to a credit check or some other verification to ensure that it is likely to pay its invoices as agreed.
What Happens If Your Business Goes Bankrupt?
If your company goes bankrupt, the factoring company may be forced to accept its losses. As the advance is secured by the company’s revenues, it is unlikely that it could pursue a claim against you directly. Therefore, your personal assets such as a home or car would likely remain even if the company ceases to exist.
Accounts receivable financing is just one of many options that your company may pursue to give itself as much financial flexibility as possible. Prior to entering into a factoring agreement, be sure to have an attorney or other trusted professional review its terms.