Factoring Receivables: What You Need to Know
Factoring receivables is a financing option that allows businesses to sell their open invoices and receive a portion of the cash immediately, helping solve cash flow issues.
If you’re struggling to make payroll, pay rent or cover other costs, you might be looking for options to float you until your outstanding accounts receivable are paid. Factoring may be a viable option to keep your business on track — still, there are downsides you should know about before deciding whether factoring is right for you.
What is factoring receivables?
Factoring is an option for business owners to access capital, without taking out a small business loan. Rather than waiting for open invoices to be paid, a business owner sells these receivables to a factoring company for an upfront advance, often 70% or more of the receivable amount. This enables the business to get the cash it needs, when it needs it.
Once the invoices are paid to the financing company, also known as a “factor,” the business receives the remaining invoice amount, minus a factoring fee that the company charges for this service.
While that’s a general overview of factoring, there are a number of different ways that a factoring agreement can be structured. Some of these include:
Spot factoring vs. whole ledger factoring
Factoring can be done for just a few select invoices, called spot factoring, or for all of your invoices.
- Spot factoring allows the business owner more flexibility to pick and choose which invoices to factor, but in some cases it also can come with higher fees or a minimum invoice size.
- Whole ledger factoring can offer lower fees in exchange for selling all of your open invoices, but you might find that you have to commit to a long-term contract.
Recourse vs. non-recourse factoring
What happens if your customer doesn’t pay? How this is handled depends on whether you have recourse or non-recourse factoring.
- Recourse factoring means you’re on the hook for the unpaid invoice and the factoring company will ask for you to repay the advance they’ve given you.
- Non-recourse financing puts the liability on the factoring company. If your clients don’t pay, the factor won’t come back to you and attempt to recoup the cost. Typically, for non-recourse factoring, you’ll need to have established, trustworthy clients. You might also be charged a higher fee for a non-recourse agreement, and we have seen at least one company also require a personal guarantee.
One way that factoring can potentially get awkward is when a factoring company starts corresponding with your customers about the outstanding invoice. Some companies offer non-notification factoring, as a way to preserve the business/client relationship. Non-notification means that the factoring company will have limited interaction with your customers.
But there are other ways to minimize the disruption, without non-notification factoring. It’s a good idea to reach out to your customers to tell them that you’re now working with a factoring company. You’ll want to phrase it in a positive light, assuring them that you’re not going out of business or in financial distress, but rather using this to enhance your working capital.
Qualifying for factoring accounts receivable
Each factoring company will have its own standards for determining who will qualify, but in general companies will take a close look at:
- The quality of your accounts receivable
- Your credit score
- Minimum monthly revenue
- Your time in business
One of the most important things that some factoring companies look at is the accounts receivable aging schedule, which shows what your customers owe you and how long their invoices have been outstanding. This is how the factor can tell whether your customers are making payments on time.
“Typically, they want to see that the bulk of your customers are paying within 90 days,” said Ken Alozie, principal of Greenwood Capital Advisors LLC in Washington, D.C., adding that ideally, “the majority of it is within 60.”
Don’t be concerned that a low credit score may keep you from being approved. What’s nice about factoring is that the factoring company focuses more on the creditworthiness of your customers, rather than on your own.
“If you have a 560 FICO, you’re not going to qualify for a lot of other types of business loans,” Alozie said. “But if you have great customers, you may be able to get a really great factoring package.”
How does factoring receivables work?
The factoring process may differ slightly between factoring companies, but the general process is the same. Once you’ve identified one or more factoring companies that you’d like to work with, you fill out an application. Depending on the company, you may even be able to apply completely online.
After your application is reviewed, you’ll receive an offer from the factoring company that includes your advance amount and fees. Some industries may be eligible for higher advance amounts, as high as 90% of the value of the invoices you’re factoring.
After you accept the offer, you’ll receive the advance on your invoices, often in a few days or less. Once your customers begin repaying their invoices to the factoring company, you’ll receive the remaining balance owed to you, minus any fees.
Factoring receivables: an example
Let’s say you’re a small business owner with $100,000 in outstanding invoices due in the next 30 days, but you need that cash now to cover some of your operational expenses.
To get access to that money sooner, you work with a factoring company. You’ll sell the invoice to your factoring company, which offers an 80% advance fee with a 3% factoring fee. Within a day or so, they’ll send you $80,000 to use in your business.
Once your customers pay the invoices to the factoring company, the factoring company will release the remaining reserve to you, minus their factoring fee. If it takes the full 30 days for your customers to pay and you’re charged a 3% monthly factoring fee, you’ll get back $20,000 minus the $3,000 factoring fee, or $17,000. Total cost of factoring: $3,000.
If the customer doesn’t pay in 30 days, you’d need to continue paying the factoring fee until they do pay, so factoring could end up getting much more expensive.
Pros and cons of factoring receivables
Fast funding: Approval for factoring can be quick, with some factoring companies allowing you to apply online. Once approved, you may receive funding within hours.
Good credit isn’t a requirement: Borrowers who may not qualify for a traditional loan because of bad credit will have a better chance of qualifying for factoring. That’s because the factoring company will place more focus on the credit of your customers than on your own credit.
Customer monitoring: Some factoring companies also monitor your clients and warn you if they see any indication that your clients may start experiencing payment issues. While you may do an upfront assessment of the creditworthiness of your customers, a good factoring company will monitor them and tell you whether a customer starts taking longer to pay or seems as though they’re running into financial problems.
It can be expensive: Factoring can be an expensive form of financing, especially if your customers take a long time to pay. When you have customers who are taking 90 days or longer to pay, factoring can get expensive, because some factoring companies will charge their factoring fee based on how many weeks or months an invoice is outstanding.
It can potentially damage customer relationships: Because a factoring company will often have at least some interaction with your customers, you risk damaging relationships if it doesn’t treat your customers well. Your customers might also be concerned about your company’s financial situation once they learn you’re working with a factoring company.
4 top factoring receivables companies
Invoice factoring may be a good fit for companies that need fast funding and have reliable customers who can be expected to pay their invoices on time. If it’s right for your business, here are a few companies to consider. To be included among the top factoring receivables companies, companies had to meet the following criteria:
- Transparent websites that clearly list costs and requirements.
- Funding available within 24 hours of approval.
|Amount||Term||Fees||Time to Funding|
|Up to $5,000,000 with an advance of 85%-90%||1-13 weeks||Weekly fee, beginning at 0.25%||Approvals as fast as 24 hours. After approval, you can receive the money in as little as a few hours.|
BlueVine offers recourse factoring for up to $5,000,000. Its easy-to-use platform connects with your invoicing system, to let you pick and choose which invoices to factor. There’s no minimum volume or termination fee, but there are a few minimum requirements:
- You must have been in business for at least three months.
- Your business must have revenue of at least $10,000 per month.
- Personal credit score of at least 530.
Businesses that serve other businesses or governments are considered eligible. Ineligible businesses include auto dealers, financial institutions and political campaigns.
2. Paragon Financial Group
|Amount||Term||Fees||Time to Funding|
|Up to $3,000,000 with advance rates of up to 90%||Typical term length is 75 days.||0.90% – 2.50% for the first 30 days||Funding within 24-48 hours after signing a contract and setting up an account.|
Paragon Financial Group offers an advance of up to 90% through non-recourse factoring. As part of the non-recourse factoring, Paragon will review and preapprove each customer that you want to factor.
To qualify, Paragon Financial Group requires monthly revenue of at least $50,000 and a minimum personal credit score of 550. It also requires a personal guarantee to secure funding, which would put your personal finances at risk if your customers don’t pay.
3. Bay View Funding
|Amount||Term||Fees||Time to Funding|
|Up to $15,000,000 with advance rates from 70-90%||Based on customer terms.||Rates as low as 0.50% per invoice||Qualification can take as little as three days. Funds within 24 hours after approval and receiving submitted invoices.|
Bay View Funding is a factoring company that works with companies in a number of different industries including staffing, manufacturing, trucking, oil and gas and wholesale. It offers large factoring maximums — up to $15,000,000. It offers recourse factoring and you can choose to factor just a few invoices or all of them, depending on what your business needs.
The application process starts by either mailing in an application, calling Bay View Funding to answer the questions required to complete an application or providing your contact information on the BayView website to have someone from BayView contact you to complete an application.
4. American Receivable
|Amount||Term||Fees||Time to Funding|
|Up to $5,000,000 with advance rates from 75%-95%||No term length specified||Rates as low as 0.80% per month||Receive funds within 24 hours after submitting invoices and being approved.|
American Receivable offers both recourse and non-recourse factoring, and its website says that companies may select from their invoices. However, according to a customer service representative, rather than spot factoring, companies who are interested in factoring typically factor all of their invoices for a longer period of time, one to two years. There may be a minimum amount required to factor and other requirements that a company will have to meet. There is no standard set of requirements — they are determined on a case-by-base basis.