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Use cases

Accounts Receivable Factoring

Cashflow is the number one challenge shared by businesses of all sizes. Even big companies tend to have more in bills and assets than cash-in-hand. This is why so many of them insist on paying with credit. In fact, some big corporations make this a condition of earning their business. For their creditors, this creates a trickle-down effect of a cashflow shortage.

Accounts receivable factoring is one of the many solutions business owners can use to solve this problem.

How Does Business Accounts Receivable Factoring Work?

This type of loan allows business owners to pass the risk of payment on to another company. That creditor fronts the majority of the money owed so the business owner has cash in-hand to meet immediate obligations. The amount paid upfront depends on the industry and the risk associated with that industry. It generally ranges from 60% to 95%.

The lender that forwards the loan charges a fee on the amount due from the unpaid invoice. This fee is usually calculated as a per-30-day rate, but it can be prorated for shorter invoice payments. When the invoice is paid, the lender takes its fee and forwards the rest of the money to the business owner. Fee rates tend to vary from 1.15% to about 4.5% per 30 days.

What Is an Example of Receivable Financing Factoring?

Bradley’s small trucking company has five truck drivers on payroll. His company transfers raw materials from a farm to a processing plant in the city. Bradley sends an invoice of $400,000 to the company for the month. His agreement says he needs to wait 30 days for payment, but one of the trucks needs $20,000 in repairs and payday is coming up for the truckers and his admin staff.

He reviews his accounts receivable process and gets a factored loan. The lender pays $90,000 upfront so Bradley can meet his financial obligations. In 30 days, when the manufacturer pays the invoice, the bank repays an additional $8,000 and keeps $2,000 as its fees. In a sense, this is like factoring accounts payable on the part of the lender.

What Are the Benefits of Factoring Accounts Receivables?

There are many alternatives to accounts receivable factoring, including:

  • Seeking a working capital loan
  • Swiping business credit cards
  • Using commercial lines of credit

Most companies find that it is easier to qualify for this type of loan.

Here are some additional benefits:

  • Benefits startups – Lenders make decisions based on the solvency and payment history of the larger borrowers, not the company owed.
  • Builds business credit – Lenders offering factored loans generally do report the loan to credit bureaus, which can build business credit.
  • Cash in-hand – Receiving most of the money upfront can mean the difference between solvency and insolvency for a small company.
  • No additional debt – Keeping debt loads low reduces the risk of further cash flow problems.
  • Provides flexibility – Providing 90-plus days for repayment is a great way to land bigger accounts, which can help small companies expand.
  • Reduces collections stress – Non-recourse factoring allows companies to pass risk and the collections process to another company with the resources to tackle it.

How Can a Company Get a Good Loan Based on Receivables?

Start by shopping around. Depending on your most immediate needs, you might make a decision based on the amount paid upfront or the percentage of the invoice charged as fees. Apply for the loan early enough to avoid making a desperate decision based on just one factor, instead of the best combination of both.

You may also need to decide between recourse and non-recourse loans. If you have no reason to believe your client will default on payment, recourse loans should suffice. In instances where a client has begun to slip in payments, non-recourse loans pass the full risk of non-payment on to the creditor. However, you may face higher fees and more restrictive clauses in your loan.

Business accounts receivable factoring is an excellent way to protect your business from cashflow problems. It is also an excellent complement to an automated accounts receivable system.

Gaviti has helped our clients improve cash flow and get paid faster. Find out how.

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