Last Updated on December 28, 2023
If your business has cash flow problems, one option that can provide an immediate cash infusion into your business is to sell your accounts receivable to a factoring company (factor). This process, known as invoice factoring, aims primarily to improve your company’s cash flow and liquidity.
After you sell your company’s outstanding invoices, or accounts receivable, to a factoring company, the factor sends you an immediate cash advance. Your customer then pays the factor, rather than your business. Once the invoice is paid, the factor releases the remaining value of the invoice to your business, minus a small factoring fee.
Factoring protects your cash flow from slow-paying customers because you get instant funds. With these funds, you can settle other urgent business expenses.
Why Companies Sell Accounts Receivable For Cash
The main reason for selling your accounts receivable is to provide your business with more predictable cash flow and to help make your business cash flow positive overall, especially if your company is struggling to stay afloat due to long payment terms or slow-paying customers.
Selling accounts receivable is a great alternative if you need funding, but have been declined by a bank for a more traditional loan. A company struggling with poor credit or problems in their financial history, like bankruptcies, should view selling accounts receivable as a great alternative too. We’ll explain why in just a bit.
If your business does receive a bank loan, but it’s not enough to solve your working capital problems, you can also turn to factoring for additional capital. And, for businesses that do not want to incur any additional debt, selling your receivables is a smart option to get cash fast without creating future problems.
Pros and Cons of Selling Accounts Receivable
Selling your accounts receivable to further finance your business can be extremely beneficial, particularly for small business owners or those whose businesses are undergoing rapid change or dynamic growth. Let’s take a look at the advantages and disadvantages of selling your receivables.
There are some significant benefits for those who choose to sell their A/R.
1. It Rapidly Improves Your Cash Flow
The primary purpose of factoring is to improve your 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.
2. Flexible Financing
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 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.
3. Minimal Limits For How You Can Use the Funds
Once you receive capital from the factoring company, you can use it in nearly any way that you would like (with the exception of purchasing expensive equipment), whether you need it to finance payroll, inventory, rent, or any other business expenditures you have.
4. Does Not Create Additional Debt
Unlike a bank loan, selling accounts receivable 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.
5. No Collateral Required
No need to stress over sacrificing and potentially losing valuable assets. When selling your receivables, a factoring company like altLINE won’t require collateral.
In the rare instance your customer never ends up paying the invoice, a good and honest factoring company will work with you to the most ideal, fair solution for both parties.
6. Support For Your A/R Department
After you finish the onboarding process 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 financing option, factoring has a few potential downsides that you need to consider before you commit to it.
1. Additional Fees That Slightly Affect Profit Margin
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.
2. Risk of Customer Non-Payment Remains
Selling your accounts receivable doesn’t necessarily alter the chances that your customer pays on-time – or pays at all. Unless you’re utilizing non-recourse factoring, you’ll be held liable for failed customer payment, just as you would if you hadn’t factored the invoice.
Factoring companies understand this is out of your control, and you should expect them to do their best to work with you to find the best solution going forward, but it’s something to be aware of. Since they provided you an advance for the invoice, they expect to receive payment from your customer.
3. Ability to Qualify Reliant on Customer Credit Score
If your customers have poor credit history, a factoring company may not want to take on the risk of relying on them for payment and your application might be denied.
4. The Invoice Factoring Stigma
If you’re considering factoring, it’s crucial to understand that there’s a difference between selling accounts receivable to a bank vs. an independent company. Because independent factors are unregulated and have a stigma of being predatory, this has affected the perception of the financing option as a whole.
Remember that financial institutions are far more regulated than independent companies and have to abide by certain rules and restrictions. This is why most choose to factor with a bank.