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Accounts Receivable Factoring: Is Factoring Right For You?

People who play musical chairs with their bills and paycheck sometimes find that there isn't a chair left to sit in. Out of desperation, they turn to the only financing option that will lend to them - payday loan companies.

If the borrower is not able to pay the loan by its term date, the whole thing easily spirals out of control. 

So how do payday loans relate to accounts receivable factoring? 

When a business runs low on cash and doesn't have financing options accounts receivable factoring, or business receivable factoring can help! But how? Just as a payday loan lender is able to advance cash to a consumer, a factoring company is able to advance cash to a business.

Now let's explore the ins and outs of business receivables factoring. 

What Is Business Receivables Factoring In 4 Sentences?

Unfamiliar with business receivables factoring? Here's how it works in 4 sentences: 

  1. A business allows a company called a factor to take over payment collections on outstanding invoices by selling its accounts receivable.
  2. The factor, or lender, advances a percentage, usually 80% - 95%, of the accounts receivable invoices' value. 
  3. The remaining percentage is held by the factor and paid once it is collected from customers.
  4. Once the remaining percentage is collected, it is sent to the business minus the factoring fee.

Now join us as we go through each component of business receivables factoring and better understand this cash flow solution.

Business Receivables Factoring In Action

Factors want outstanding invoices. If a business wants a factoring loan it must apply and be approved for invoice factoring. 

Some of the qualifications for a factoring loan are: 

  • The business must be a B2B or B2G business 
  • The business must meet a certain volume of invoices per month
  • The business must be active for a certain number of years

Note that accounts receivable factoring and factoring loan qualifications change based on the factoring company.

Half of all invoices are not paid on time(source)

Do Factoring Loans Charge High Interest?

Factors don't charge interest, instead, they charge fees that can follow different structures. Some include a flat fee, a tiered fee, and a fee plus the prime rate. While these fees aren't as high as a payday loan, they're still among the highest business financing fees. 

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Are There Additional Business Receivables Factoring Fees?

Just as a payday lender can have setup fees, late fees, and more, some factors charge additional fees which can include setup fees, monthly minimum fees, servicing fees, and early termination fees. Be sure the factor discloses that there can be additional fees along with a complete schedule of those fees.

Fees generally can range from 1% to 5% of the factored invoices' value per month. The fee is applied to the total amount of outstanding invoices, not just the advanced amount.

 For example, if a company factors $10,000 in total invoices at a rate of 4% per 30 days. It is advanced $8,500. Its total fee is $400 every 30 days.

The Factoring Loan Spiral

When a payday loan borrower is not able to meet ever-growing loan payments, they fall behind, triggering more fees, higher interest, and still higher minimum payments. While the scenario with factors isn't as bad, companies can find themselves in a similar spiral.

Once a company's cash flow begins declining, it will be unable to fund new projects for growth. In the most critical cases, a lack of cash flow leads to an inability to maintain daily operations. At that point, a company is probably days away from filing for bankruptcy.

Other companies experience a temporary decline in cash flow. To get money coming back into the company, they may turn to factoring loan options. Once this is done the company can continue funding growth but at the expense of revenue. Remember, the factor is charging an account receivable factoring rate and taking a chunk of revenue with them.

Why factoring is needed(source)

For companies that are able to stabilize their cash flow but not get it back to where it was, they'll need another injection of cash. They turn to the factor for a quick fix and on it goes. These cycles can continue until the company is able to sustain itself (i.e., cash flow increases). Assuming a company meets the factor qualifications listed above, it's easy to get another infusion of cash at the expense of revenues.

The above is why accounts receivable factoring is a last resort as a financing option for businesses. Not only does business receivables factoring lop off a large amount of revenue, but additional fees can pile on, further decreasing revenue. 

Another component of factoring to consider is loss of control. Before factoring, a business collects payments directly from customers. What that customer experience looks like is completely up to the business. After invoice factoring, that entire process is taken over by the factor. Learn more about the business operations changes factoring can cause here.

Is Taking Factoring Loan A Good Choice?

Wondering if a factoring loan is right for you? Here are some key takeaways from this article: 

  • Accounts receivable financing helps you fund your business and get paid faster
  • AR factoring is a cheaper and smarter alternative to bank loan financing
  • There is no interest associated with accounts receivable factoring, but other rates and fees can rack up your expenses
  • Business receivables factoring can be risky so consider all your options before choosing factoring to fix your cash flow problems
If your company is considering an invoice financing or factoring solution, it may be time to consider something even better. Apruve can help you set up a trade credit and A/R automation program for your business buyers, extending your working capital while enhancing the buyer experience. Learn more about Apruve or contact Apruve’s specialists to sign up for a demo today!

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Apruve enables large enterprises to automate long-tail credit and A/R so you can stop spending 80% of your time and resources on 20% of your revenue. We partner with each of our customers to solve their unique credit, payment, and accounts receivable challenges and build the right credit solutions for your markets, customers, and goals. 

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