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Use cases

Accounts Receivable Factoring

Accounts receivable factoring provides a short-term boost to cash flow. Small business owners accomplish this by selling their invoices at discounted rates to a factoring company, which is often different from a traditional lender. The business receives a large percentage of the invoice value, and the factoring company maintains contact with the customer to secure the rest. Upon successful payment, it keeps a portion for itself and pays the remaining amount to the business owner. It should be noted that accounts receivable factoring should only be considered for bad debt that a business feels they are unlikely to collect on. 

What Is the Cost of Accounts Receivable Factoring Services?

Like most financial products, the rates vary across different lenders, so take the time to shop around for good rates. Forbes estimates a range of 0.5% to 5% for these services and shares that fees are usually variable. Companies advance as much as 97% and as little as 70% of the total invoice. The average business can expect to receive an 80% advance.

Lenders may use the following criteria to set specific rates for customers:

  • The industry: Some industries, such as construction and healthcare, are riskier than others. As a result, factoring companies may charge higher fees for businesses in these industries.
  • The creditworthiness of the customers: Factoring companies are more likely to charge higher fees for businesses that have customers with poor credit histories. Consequently, effective collections management is critical to securing reasonable rates.

According to the U.S. Chamber of Commerce, the more time customers take to pay, the higher the long-term cost of factoring receivables. That’s because lenders typically charge a percentage fee of the amount each month or each week. Confirm the cycle used because 1% per week will cost you more than a contract for 2% per month.

What Is the Factoring Accounts Receivable Formula?

The formula ultimately depends on the offering and the agreement provided by the lender. Consider the following example.

Company XY has employed a two-week invoice payment cycle for two years. However, it recently secured business with Big Client AB. It provided 60% more work at a 40% higher rate but required a net-30 invoice turnaround. Company XY jumps at the opportunity but finds it is running out of cash halfway through the month.

Lender QR provides the following terms for the $500,000 invoice:

  • 80% advance on invoice
  • 1% fee for the first month
  • 2% fee for the second month
  • 3% fee for the third month
  • 5% fee for each succeeding month

What happens if Big Client AB pays within the first month?

Company XY receives an 80% advance of $400,000.

500,000 x 0.8

= 400,000

Lender QR takes $5,000 for its factoring fees.

500,000 x 0.01

= 5,000

When Big Client AB settles the invoice, Lender QR pays the remaining $95,000 to Company XY.

500,000 – 400,000

= 100, 000

100,000 – 5,000

= 95,000

What happens if Big Client AB pays within the third month?

Company XY receives an 80% advance of $400,000

500,000 x 0.8

= 400,000

In Month 1, Lender QR takes $5,000 for its factoring fees.

500,000 x 0.01

= 5,000

In Month 2, Lender QR takes $10,000 for its factoring fees.

500,000 x 0.02

= 10,000

In Month 3, Lender QR takes $15,000 for its factoring fees.

500,000 x 0.3


When Big Client AB settles the invoice at the end of Month 3, Lender QR pays the remaining $70,000 to Company XY.

500,000 – 400,000

= 100,000

100,000 – 5,000

= 95,000

95,000 – 10,000


85,000 – 15,000


What Are Recourse and Non-Recourse Agreements?

The example above may bring the following question to mind: What happens if Big Company AB does not pay at all? Who assumes the risk? The answer comes down to the type of agreement at the time the lender extended the loan:

  1. Recourse agreements. The lender can seek repayment from the business owner if Big Client AB does not pay. This may take the form of Company XY supplying a new invoice of equal value or buying back the initial unpaid invoice. This type of agreement is more common in high-risk industries or high-risk businesses.
  2. Non-recourse agreements. In this case, the factoring company assumes the risk of non-payment. It may be willing to take this chance due to the high quality of Big Client AB’s credit rating and reputation. Company XY is not liable for repayment if Big Client AB does not pay. This option usually carries a higher fee because it involves more risk for the lender.

What Are the Benefits of Factoring Accounts Receivable?

Most experts agree that factoring services are expensive. Few companies can sustain regular discounts on the amounts owed by customers. However, it serves a critical role in the business world because of the benefits provided:

  • Small businesses with sparse credit histories can secure loans. It is not a traditional business loan, so lenders focus on accounts receivable versus business credit scores or records. This opens the door for more businesses to get capital to meet cash flow needs.
  • Provides immediate solutions to cash flow problems. As noted in the example, companies can access a significant sum within days or weeks instead of waiting for invoices to be paid. This could be critical for compliance, such as making payroll or submitting tax payments.
  • Does not affect credit history. Traditional lenders may determine loan amounts based on debt load relative to revenue. However, lenders may not include factoring loans in their calculations unless they conduct detailed accounting reviews.

How Can Automated Accounts Receivable Software Assist with Factoring?

It is best to avoid the need for accounts receivable factoring in the first place. Accounts receivable automation can boost on-time payments and reduce debt write-offs. It facilitates healthy cash flow management, eliminating the need for factoring services. However, if you need immediate cash to find a big project or handle an unexpected expense, proof of steady cash flow may reduce your rates. That’s because lenders now view your business as low-risk.

Are you ready to see what Gaviti can do for your collections process? Speak to a Specialist to get started.

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