Selling Accounts Receivable to Finance Your Business
Last Updated on August 26, 2021
If you’re having trouble with cash flow in your business, one option that can provide you with an immediate influx of money is to sell your accounts receivable to a financing company. This process is also known as factoring, and it works primarily to improve your company’s cash flow and liquidity.
In factoring, you sell your company’s outstanding invoices, or accounts receivable, to a factoring company. This company pays you immediately for these invoices. Then, it waits for your customer to pay his invoice and collects the money for itself when he does.
Factoring protects your cash flow from slow-paying customers since you get instant funds from the factoring company to take care of other business expenses.
Why Would You Want to Sell Your Accounts Receivable?
The main reason for selling your accounts receivable is to provide your business with predictable and increasing cash flow, especially if your company is struggling to stay afloat while waiting for customers to pay their invoices.
You may need to sell your accounts receivable if you need funding, and a bank declined your business for a loan. A company struggling with poor credit or problems in their financial history, like bankruptcies, should consider factoring, too.
If a business does receive a bank loan, but it’s not enough to improve its cash flow, they may turn to factoring for additional capital. And, for businesses that do not want to incur any additional debt, factoring is a smart option to get cash fast without creating future problems.
Pros and Cons
Selling your accounts receivable to finance your business can be extremely beneficial, but it does pose some risks. Let’s take a look at the advantages and disadvantages of factoring.
Factoring is a fantastic fit for new and rapidly growing businesses, and it frequently receives high approval ratings from participating companies.
Rapidly Improves Your Cash Flow
As described above, the primary purpose of factoring is to increase your company’s cash flow. You don’t have to wait for clients to pay their invoices to earn a profit. Instead, the factoring company purchases your business’s invoices at a discount, sends you an advance payment for the invoices, and collects their payment when your customers pay.
The cash flow is predictable, too, so it takes away much of the worry you experience waiting for your customers to pay.
Factoring works well for growing companies because you can adjust the volume of invoices sold as your business expands. Plus, you get to choose which customers and invoices to sell, so you can focus on selling and earning from slow-paying customers while retaining the total profits from your clients that pay quickly.
No Standards for How You Can Use the Funds
Once you receive capital from the factoring company, you can use it in any way that you would like, whether you need it to finance payroll, inventory, rent, or any other business expenditures you have.
Does Not Create Additional Debt
Unlike a bank loan or receivable financing, factoring adds no new debt to your business’s records. This way, you can earn instant cash flow without worrying about how it will affect your finances years later.
Support for Your A/R Department
After you agree with a factoring company, they will assist your A/R department with management and collections. This assistance allows your business to focus on its core goals. However, this support may also become a disadvantage because you give up some control of your business’s customer relations.
As with any financial transaction, factoring has shortcomings that you need to consider before you commit to it.
There are two types of fees you will encounter in factoring: invoice-dependent factoring fees and administrative fees.
A factoring company determines your invoice-related fees based on the number of invoices you are selling and the credit of your clients. You agree upon these fees at the start of your relationship with the factoring company.