Selling Accounts Receivable to a Factor - the How and Why

How Accounts Receivable Factoring Works
How Accounts Receivable Factoring Works. Imagezoo/Getty Images

Selling Accounts Receivable to a Factor to Finance Your Business

If you need money for your business, but you don't want to or can't get a conventional loan, consider accounts receivable financing (also known as factoring) as an alternative source of business financing.

What is Factoring?

Factoring means that someone will buy your accounts receivable and they will do the collecting. You can also sell your invoices directly to the factor.

The buyer obviously cannot give you full value on your receivables, because they don't know whether they will be able to collect and because it will take a good deal of time and money for them to check credit on all your customers and to run the collections process. The factoring company will require you to prepare an accounts receivable aging report, so they can see how long your customers have owed you the money.

What Can I Expect to Be Paid? How Long Does It Take to Get My Money? 

Factoring companies pay based on (1) the length of time the receivables have been outstanding, (2), the number of receivables, and (3) the credit ratings of your customers.

The factor will review your receivables and give you an initial amount, probably no more than 80 percent on the total, within a few days. Then they will charge a fee for the actual collections of 2% to 6%, depending on how difficult the receivables are to collect.

With the initial discount on the purchase of your receivables, and the fees, you will probably get no more than 40 percent of your receivables. That's just an estimate; your costs might be different.

Is Factoring Legal?

Factoring is a $150 billion dollar industry, and it has been around for a long time.

Factoring companies are legitimate businesses. They make their money by knowing the value of receivables and being good at collecting on them. The International Factoring Association, the factoring industry organization, has a "factor search" you can use to find a factor. SCORE suggests factoring as a source of quick cash.

What About My Customers? 

The factoring company wants to treat your customers well, for three reasons:

  1. The factoring company wants to get the payment.
  2. The factoring company doesn't want to destroy your relationship with your customers because they want your company to continue to rely on them in the future.
  3. The factoring company must adhere to the same collections laws as other companies. 

Can I Use a Factor on a Continuing Basis?

Many factoring companies become de facto outsourcing for accounts receivable. That is, you could continue to turn your receivables over to the factor so you don't have to spend the time and money to collect. If you have individual customers or clients, you might want to collect personally, but if your customers are other businesses, you might decide that factoring can save you money and hassle.

How Do I Select a Factor? 

Do an Internet search to find a list of factors who work in your state.

Then select several to interview. Some key points to look for when selecting a factor:

  • What experience have they had with factoring? How long have they been in the business?
     
  • Who will actually be doing the contacts with my customers? What is this person's demeanor? Is he/she friendly? Courteous? Be sure that the factor will not destroy your goodwill with your customers.
     
  • How does the factor contact customers? If possible, review the phone scripts and letters they use, to gauge their professionalism and courtesy.
     
  • Does the factor refer accounts to collections? What criteria do they use for doing this? Do they notify you they are turning over an account to collections? If you have a continuing customer who doesn't pay bills, you need to know this. The factoring company should be in communication with you about their interactions with your customers.

    Factoring can provide you with funds more quickly than a traditional bank loan, but it is more expensive. If you need cash, it is a way to get some fairly quickly.

    Back to 5 Ways to Finance Your Business in Difficult Financial Times

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