Accounts receivable factoring, aka invoice factoring, is a financial tool used by small and medium-sized businesses to help them maintain steady cash flow. Businesses convert their outstanding company invoices to immediate cash flow through a third-party financial intermediary known as a factoring company (“factor”).
Factors fund transactions by purchasing their client’s accounts receivable and accelerating cash flow instead of their client waiting 60+ days for their customer to remit payment.
As every business owner understands, cash flow is essential to ensure the successful, continuous operation of their business. This is why it’s important to know the different forms and types of invoice factoring.
What is Recourse Factoring?
When a business opts to factor with recourse, a factoring company uses their accounts receivable as collateral to advance funds. The factoring company takes over the invoice collection, and your business receives a portion of the face value of the invoice upfront. The remaining balance is held by the factoring company until your customer pays the invoice. If the customer fails to pay the invoice, you are ultimately liable. The factor company may require you to substitute another invoice of similar value in its place or repay any advance amount and factor fees.
Typically, invoice factoring with recourse requires the personal guarantee of management or the owners as they must maintain liquidity to purchase back non-performing accounts receivable taken as collateral by the factoring company. It is the most commonly used form of invoice factoring. Generally, recourse factoring companies are able to offer lower factor fees and higher advances as there is less risk of a loss on collection of accounts receivable.
What is Non-Recourse Factoring?
If the agreement between the client and factor calls for “no recourse” it means the factor does not have the option to request the client repurchase unpaid or past due factored invoices. When you have factored an invoice under a non-recourse factoring arrangement, the factor company assumes the risk of nonpayment. Should your customer go out of business, and you have a non-recourse contract with the factor company, the factor will absorb that loss without any financial repercussions for your company.
Non-recourse factoring typically only protects you and your business in the event your customer closes their doors before they pay their invoice. Advance rates may be lower and factor fees may be higher for the client when compared to recourse factoring since the credit risk is borne by the factoring company.
When considering entering into any type of accounts receivable factoring contract, it is important to determine what your liability is in the event that other problems occur with your customer. Should the contract be non-recourse, talk to the factor to determine how they define non-recourse factoring.
Types of Accounts Receivable Factoring
There are different types of accounts receivable factoring that you should understand so you can choose the best type for your business model.
- Regular Factoring: With regular accounts receivable factoring, you sell all of your accounts receivable to the factor on a continuing basis. This ensures that you have a steady stream of cash flow to meet payroll and pay suppliers and vendors. It simplifies cash flow management because you always know where your cash flow will be coming from.
- Single Invoice (“Spot”) Factoring: This is the ideal solution for companies that are simply in need of immediate cash flow and want to monetize a single invoice or two without committing to a long-term contract. It doesn’t require a multi-year contract and provides you with the flexibility of selling invoices only when working capital is needed. There is no obligation to sell a minimum number of invoices per year over the term of a contract.
Spot factoring is especially helpful in the area of construction financing. If you are a contractor or subcontractor and are going to be working on a new construction project, you may have a lot of one-time capital needs throughout the lifecycle of the project. Spot factoring can be an excellent solution for you to cover supplier & material costs or payroll on an as-needed basis. There is no long-term contract.
Selecting the Best Factor Company
Selecting the right factor to work with is essential so your company has a source for working capital that meets the needs of your business. The questions you ask when choosing a factor company should be tailored to fit your business:
- Industry knowledge and experience: Does the factor have hands-on experience working with companies in your industry, and how extensive is their experience?
- Financial resources: Does the factor have the financial resources to fund the necessary transaction size and support your growth plans? What is the amount of factoring facility the factor can provide?
- Customer service and immediacy: Does the factor have a presence in the same area that you operate in? If you need to get in touch with your Account Manager, how quickly will they respond?
- Factoring programs: Do factoring programs include single invoice factoring and ongoing factoring programs? Does the factoring company require that you factor all of your accounts receivable, or will they also factor a single, one-time invoice for immediate working capital to get you over a period of slower cash flow?
- Recourse and non-recourse: Are recourse and non-recourse factoring programs available? Consider working with a factor that provides both types of factoring. Some businesses will be better candidates for recourse factoring than others.
- Other products: Does the factor offer other financing products, such as purchase order financing and trade & import financing? A single source for alternative financial funding can be more efficient and facilitate seamless business transactions.
- Funding turnaround time: How long does it take to receive the advance for factored invoices? This can be especially important when you are in a pinch and have last-minute customer projects or unexpected expenses pop up.
- Fees and discount terms: What are the fees charged and discount terms, and how are they calculated? Additional fees may include monthly (or contract minimums), applicable transfer fees, servicing fees, legal fees, termination fees, and the initial startup fee. Make sure the factor is upfront with you regarding its rates, service charges, and fees.
Factoring can close serious gaps in cash flow and allow you to continue operations without worrying about how to cover necessary expenses. Not all factoring options are alike, however. We know that every business is unique, and each deserves an individual approach to solving their cash flow shortfalls.
With flexible invoice factoring structures, Capstone will customize a program specific to your business that will help you achieve your funding goals. By utilizing Capstone’s invoice factoring services, you can shift your focus from waiting on cash to working on your next project without the stress of inconsistent cash flow.
Capstone also assists its clients by offering a number of other services, including:
- Purchase of accounts receivable with or without recourse
- Collection of accounts receivable
- Underwriting credit line on client’s customers (credit risk protection)
- Non-legal contract review
- Bid review and support letters
- Sorting out disputes
- Funds control – making sure client’s vendor/suppliers get paid
- One-on-one business consulting and mentoring
- Budgeting and forecasting support
- Access to bonding
- Leadership and executive development
Understanding your invoice factoring options and working with the right factoring company is essential as it ensures you have adequate access to cash flow to fuel the growth and long-term success of your business. Speak to Capstone about accelerating your cash flow today.
