Apart from the unpleasantness often associated with tracking down overdue invoices, collecting accounts receivables takes time and attention away from your business' primary function - serving your customers. To better serve their customers and maintain focus, some entrepreneurs have taken a different approach with their accounts receivable collections.
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It's called "factoring" receivables and here's how it works. Usually, a business has to wait 30, 60, or even 90 days to receive payment on invoices for products that have been delivered or for services that have already been rendered. During this time, the business doesn't have access to the dollars tied up in the invoice, and, therefore, can't put those dollars to work making money for the company. It's the same thing as making an interest-free loan to your customers.
Factoring receivable companies are finance firms that specialize in purchasing companies' invoices. By selling your invoices to a factoring receivable company you gain quicker access to the majority of the money tied up in your business' accounts receivables.
Generally speaking, the factoring receivable company will give you cash for as much as 90% of the invoiced amount upfront. You'll receive the remaining 10% (minus the factoring receivable company's service fee) once the company receives payment for the invoice.
The fees charged by factoring receivable companies largely depend upon the credit-worthiness of your customers and the amount of business you are doing with the company. Expect to pay at least a few percentage points of your invoices to the factoring receivable company.
There are a number of advantages to factoring your receivables. One big reason is that it gives you the ability to immediately access cash owed to your company. For some businesses, this minimizes the need to incur debt for operations while waiting for invoices to be paid.
Another advantage of factoring is that it provides a smoother, more consistent cash flow. Instead of wondering when you will receive payment from your customers, you can accurately predict when you will receive payment based on the terms of your relationship with the factoring receivable company.
Finally, factoring eliminates the need for you to do your own collections. Factoring receivable companies are run by professionals who specialize in collecting and tracking invoices. This translates into an overall reduction in the amount of bad debts and fewer headaches for your business.
However, factoring also has a downside - cost. Factoring is not cheap. The percentage that you pay the factoring receivable company ultimately costs more than you would pay for a short-term commercial loan. For that reason, factoring should never be seen as a long-term solution, but rather as a way to generate quick cash when you really need it, most often during a period of rapid growth.
Also be aware that factoring receivable companies make their money based on the volume of invoices they purchase. Unless you have invoices in excess of $10,000, you may have a difficult time finding a company willing to do business with you.