Unconventional Financing: Accounts Receivable Factoring

A business that has recently started operations or is experiencing sudden expansion requires working capital to grow. Some companies need inventory and can obtain credit from suppliers. Others need equipment and can obtain financing from a manufacturer. However, other options are necessary if your business needs cash simply because of selling on credit terms to customers.

In many cases, there’s no likelihood of borrowing against your accounts receivable from a bank. That avenue is normally closed to you unless your business is well established and has a long credit history. Banks are cautious about the risk of loaning money to newer companies with a shortage of cash flow.

A lack of cash is exactly what occurs when a business is waiting for payments on past sales. But selling to other companies—particularly large well-known operations—usually demands that you wait for payment long after you delivered the sale. Fortunately, there is a financing opportunity for businesses that sell to other commercial enterprises. Accounts receivable factoring involves transferring the rights of your business to future customer payments in exchange for obtaining cash right away. The “factor” then collects the future payment of your company’s invoice.

By using factoring, you sell accounts receivable at a discount. This provides immediate cash for the sales you were only able to make by extending credit terms. The necessity of providing credit when selling to large creditworthy organizations is converted into a benefit for your business rather than a burden. Factoring of accounts receivable is possible for a business of any size and credit history. The most relevant issue in factoring is the financial strength of your customers.

Arranging accounts receivable factoring is a more flexible application process than trying to obtain a bank loan. Consequently, funds are customarily provided in a few days instead of after several weeks. The lending decision is not based upon analysis of financial statements and tax returns of your business. Instead, factoring companies specialize in evaluating the strength of your invoiced customers to make future payments.

Companies with seasonal sales or young businesses with uneven sales patterns commonly use factoring of accounts receivable. For a start-up operation, traditional bank lending is difficult to attain due to the company’s lack of a financial base and earnings history. In addition, even a well-established organization cannot justify a credit line increase due to a temporary cash shortage caused by fulfillment of a few large sales on credit terms to customers.

Factoring of accounts receivable is a viable financial vehicle for your business if you have customers that are highly creditworthy. Even if this describes only some of your customers, you may factor the invoices issued to that group but not the accounts receivable of smaller customers. The optimal invoices that are acceptable for factoring are those issued to government entities, colleges, and large public companies such as IBM or Wal-Mart. However, factoring is also available for accounts receivable from local companies that have a known and highly regarded creditworthiness. A factoring company that specializes in your industry is familiar with these names and knowledgeable about factoring of invoices issued to them. So you can use factoring for your invoices from selling to commonly known companies in your industry.

In addition to having creditworthy customers, accounts receivable factoring requires you to provide assurance that the sales are final. That is, there must be no contingencies or disputes. Evidence is required that your customers have accepted the sale and agreed to the amount on the invoice. This is often accomplished by having a signed purchase order and delivery receipt from your customer that matches the invoice you issued.