Factoring Accounts Receivable – What is factoring?

Factoring of accounts receivable can provide a growing business with accelerated cash flow to assist with its working capital needs.  Factoring is a method of financing where a business either 1) sells its accounts receivable to a factor at a discount or 2) receives an advance against its accounts receivable.  Typical advance rates range from 70-85% of qualified accounts receivable.  Accounts receivable that typically do not qualify to be factored include aged invoices, such as those older than 60 days from date of issuance; customer account balances where a significant portion is aged and customer account balances that make up an unusually significant portion of your overall accounts receivable balance.  When you either sell or receive an advance against accounts receivable you are usually doing so on a recourse basis meaning that your business is financially responsible for uncollectible accounts and disputed invoices.  There are non-recourse factoring arrangements available, but they are usually more expensive and limited.

Which businesses are the best candidates for factoring? –Customers with good credit ratings and solid payment histories are an absolute necessity for your business to work with a factor.  Your business should also be capable of maintaining at least $10,000 in monthly receivables consisting of numerous

higher dollar value transactions and invoices for factoring to be practical.  Factoring is generally not a good solution for businesses generating thousands of small dollar value invoices.  Also, businesses that issue numerous customer credit memos due to returns, exchanges, invoicing issues, customer disputes, price adjustments, rebates and buy/sell netting may find it difficult to factor since it is difficult to assess the quality and collectability of their accounts receivable.

Almost all product based businesses meeting these criteria can be good candidates for factoring.  Many service based businesses can also use factoring, but your business may need to use a specialized factoring service if it is in certain higher risk industries such as construction or health care.

The costs of factoring – Factors charge a fee for advancing cash against your qualified accounts receivable invoices.  This fee is known as a discount rate which generally ranges from 3 to 5% of the invoice amount advanced.  Factors which influence the fees and discount rate include:

  • Credit worthiness of your clients
  • How you bill and the number of invoices
  • Your products and your industry
  • The type of factoring arrangement

Keep in mind that factoring agreements never reflect this discount rate in percentage terms since it is technically not interest and

it is not in the factors best interest to do so.  When you convert the discount rate to interest an interest rate most factoring arrangements equate to interest rates of 20-35%.

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