How does Factoring Work?
There are three entities involved in factoring – the Debtor (likely your customer), the Receivable (the invoice amount they owe), and the Factoring Company.
The Debtor is critically important here because they are essentially the entity paying off the Receivable. The more likely they are to pay back the Receivable, the more credit worthy that Receivable is as collateral.
The Receivable is just the debt itself. That may be the amount you have invoice a customer for services rendered along with the terms by which they are going to pay back, such as Net 30, Net 90, etc.
The Factoring Company is the 3rd party that is going to lend you the capital you need based on their expectation that they will be able to collect from your Debtor.
As part of this relationship, the Factoring Company will become the new recipient of your Receivables, essentially collecting from the Debtor, collecting a fee as a percentage of the receivables.
How much does Factoring Cost?
Factoring is considered a high risk proposition for the Factoring Company because there is always the chance that the Debtor will not pay out on the Receivable in question. Like any high risk credit item, the fees for Factoring are higher than traditional loans.
How much higher? It can be steep. Up to 30% in interest steep, although rates start around 8% and vary based on the collectability of the Receivables.
How Quickly can I get Access to Cash?
Most businesses choose to factor receivables because they need immediate access to cash. It’s reasonable to assume you can get access to cash in less than a week based on how quickly the Factoring Company can assess the value of your Receivables.
How do I Qualify for an AR Financing/Factoring Loan?
Your qualifications will be based on the quality of your Receivables above all else, although the overall health of your business could be a factor as well. The most important asset that will be considered is the consistency of your receivables.
Beyond your receivables the Factoring Company will want to know that your business as a whole is healthy, so they will likely request basic financial documents like your income statement, balance sheet and potentially bank statements so they can verify your balances and transaction volumes.
Many businesses deal with the inherent issues of cash flow, and when receivables start to stretch out even past 60 days the needs for factoring become very apparent. The key to managing a factoring relationship successful is being able to balance the costs of capital with the needs for capital. With rates as high as 30%, many companies cannot sustain that hard of a hit to their bottom line. For those that can, factoring can be an invaluable tool for pulling your receivables more closely in line with your payables.