Some businesses that are generally profitable still fall on tough times due to the amount of time it can take for customers to pay invoices. It’s not always feasible for a company to wait a month or even longer to get the cash they need via a paid invoice. In those cases, some companies consider factoring receivables to boost their cash flow. This option is among the oldest methods of getting working capital.
The Basics of This Approach
Companies that want to get cash in this manner generally sell some of their outstanding invoices at a discounted rate to a third-party company, known as a factor. The factor then agrees to assume the risk associated with that receivable in exchange for quick cash.
Each invoice is assigned a value based on its age. When factoring receivables, the newest ones are most likely to have higher values. Invoices that are older than 90 days generally are not dealt with at all because factors deem those to be too risky since customers may neglect to ever pay.
It’s important to note that once a factor takes control of certain invoices, it also handles all the specifics regarding accepting payment from customers. Furthermore, once the invoices are paid, the factor will give any remaining balances back to the company, minus a service fee for assuming the related responsibility.
Advantages to Consider
The majority of companies look to this option after discovering they do not have the time nor desire to apply for a loan. Some may also have already tried to get other types of funding, but were turned down. Some factor companies can give funding to their clients in as little as 24 hours.
Also, turning receivables into profits is dependent on a line of credit based on sales and customer credit. That means if your own credit history is less than ideal, those personal financial blemishes won’t adversely impact your ability to be a candidate for this funding source.
Factors don’t function as collection agencies, so if customers fail to pay their outstanding balances at all, the companies will likely be responsible for the aftermath. Furthermore, some establishments that specialize in factoring receivables may charge fees that are higher than rates associated with loans. Furthermore, there are contracts associated with factor agreements, and some of them may be lengthier than clients would prefer.
There are many things to think about before deciding to convert invoices to cash with the help of a factor, but for some companies, this alternative is a reliable and relatively straightforward way to increase business capital.