Benefits Of Factoring Account Receivables
Businesses are a support system and backup for the economy. After a period of recession or economic depression, the economy regains its stability if businesses are self-sufficient. If the businesses have working capital, capability to expand, hire and grow, the road to economic recovery becomes less painful for the business itself and the economy.
Similarly, a business can make money only if it has money. This is specifically true for small businesses and startups. In the initial days, your business is growing. Clients are interested in your businesses because your product is great. You’re about to sign in that biggest project and client for your business.
Do you have enough funds and working capital to fulfill that biggest order?
A big full stop will come in the way of your dreams if you’ve not enough working capital. But, the financial institutions have intervened to help the businesses fulfill their working capital needs without taking a loan.
In this blog, we’re going to talk about the factoring of account receivables and their benefits.
What Is Account Receivables Factoring?
Factoring is often replaced with different terms like debtor financing, account receivables factoring, or receivables factoring. Different businesses use a strategy to get instant cash by selling their debtors to other financial institutions or companies. It is referred to as factoring.
Factoring is also often known as discounting of invoices.
If we formally define account receivables factoring, it will be,
‘A company sells its invoices or account receivables to another company or financial institution at a discounted price. The selling company instantly gets the cash. The buyer makes the profit as a difference of discounted price and actual invoice value at the settlement of debt by the debtor in the future.’
The incentive for the buyer is profit, and for the seller is instant access to cash for meeting the working capital needs of the business.
This technique is often used to accelerate the operating cash flows of the company.
How Does Factoring Works?
The process of factoring between any company and the buyer goes through some legal steps and procedures. Here is a description of how does the process of factoring works.
- A regular sales agreement takes place between the selling business and its customer.
- The customer is invoiced just after the delivery of the product or service.
- Now, the selling business wants cash. AT Star is a buyer company. The selling business presents the invoice to AT Star and gets it discounted by the company. They purchase your invoice, and you get 80% of the invoice. In general, 20% amount is kept in reserve.
- Your customer appears to AT Star at the due time of settlement and settles the payment in your name. The remainder, 20% less the transaction fees and charges, is sent to your company.
Benefits Of Factoring Account Receivables
We have understood the factoring process and its working. But, the question is that why a businesses go for factoring their invoices with a third party?
What are the benefits or perks they see in discounting the invoices? Let’s walk through the benefits of factoring for a business.
1) Immediate Access To Cash
The most alluring feature of invoice factoring that every business falls to is immediate access to cash. When you’re selling your invoices to a third party, you don’t have to wait for 60 days or 30 days, or 90 days to get paid for the products or services already delivered. Any business considers it a risk when their cash flow is declining due to the long terms of credits.
A business’s cash flow instantly improves by discounting the invoices with third parties. You get instant cash to fund your short-term investment opportunities, settle your bills, or even avail any scaling opportunity for your business.
2) Good Source Of Short-Term Financing
If a business is running short of cash and opts for short-term debt, it will only add to the company’s liabilities. The short-term loans will do nothing to your business’s financial health.
Some of the consequences that you might get prepared for in short-term loans are:
Less liquidity, bounding your assets as collaterals, a negative signal in the market, your current assets are less than your current liabilities, and many more.
When you have a good alternative to selling your invoices to professional third parties, you are on time for your short-term financing. And all of this happens without hurting your business’s reputation or liquidity.
3) Your Liability Is Shared With the Factoring Company
When you sell a service or a product to someone on credit, that customer becomes your liability. Yes, I said liability. Because now you’ve given away services, and your cash availability has become dependent on the customer.
When he pays you the cash, only then will you have a positive cash flow. It becomes a liability as you might have to sacrifice a very alluring investment opportunity due to the non-availability of liquid funds. Your business might need to procure more inventory for fulfilling orders. But again, you’re running out of cash for procurement.
When you discount your invoices with third parties, you’re sharing a liability. The professionals take over your burden and help you come out of a crisis. You can get all your cash needs fulfilled without pushing your customers for early payments.
4) No Credit Checks Are Required
Probably, the best thing about invoice factoring is fast and easy processing. Unlike borrowing, the factoring company doesn’t run credit checks on the invoice-owning company. The factoring company doesn’t look into the creditworthiness of the business. They only take the guarantee of disputes or frauds.
Secondly, the only thing which is of prime importance in any invoice factoring transaction is the value of the invoice. Therefore, the businesses can easily avail of the account receivables factoring for a more hassle-free payment flow. In other words, factoring is not subject to any kind of credit check for the company selling its invoices.
5) You Can Save Your Time For Customer’s Credit Check
In business and in personal life, time is money. When a business is flourishing or enjoying the growth era, time becomes more valuable and critical to your success. The businesses can also save their time and efforts to run credit checks on their customers to assess creditworthiness.
Most factoring companies have a vast database and expertise in credit checks. Therefore, when you sell your invoices, the factoring company minimizes the risk of your customer’s defaulter by running the credit check for you. You can take on the bigger commercial clients without worrying about the creditworthiness with factoring.
6) No Give-Up Equity Is Required
In times of financial distress and depression in incoming cash flow, most companies and businesses have to decide to give up their equity by selling to third parties. It doesn’t only involves the selling of equity, but a business also loses control over a part of business operations.
However, factoring is a process that works as an opportunity for businesses sinking in the depression of cashflows. Factoring doesn’t require you to give up your equity or sell parts of your business operations. A purely time-based agreement is made between the business and third-party factoring company. You can extend the agreement based on your requirements.
7) You Can Entertain Your Customers On Their Terms
Most startups find it hard to accommodate their commercial clients and big customers in terms of credit. In the growth stage of business, cashflows are very critical to business success. However, maintaining healthy relationships with clients is equally important.
When most clients expect a 60-days term or 90-days term for payment of invoices, your savior is factoring. You can entertain your customers as well as get instant cash for your business requirements. Get yourself covered by factoring in your invoices.
8) Ideal For Small Businesses And Startups
The cash flow problems are not more common in MNCs and large corporations. The shortage of working capital is mostly a challenge for small businesses or growth-stage startups. Factoring the invoices is a great deal for these types of businesses.
You can meet your working capital needs without hurting your customer relationships and proving yourself creditworthy of getting a short-term loan.
9) You Can Increase The Line As Per Your Requirements
The factoring line of credit is better than the banking line of credit for all the good reasons. Besides fast access to cash, the factoring line can be increased or decreased as per your requirements. You are good to increase your line as long as your invoices increase and your customers have favorable creditworthiness.
This makes factoring a very suitable solution for growth-stage companies looking for financing to expand their business.
10) Your Credit Worthiness And Payment Speed Increases
When you’re instantly getting paid for a portion of services provided to customers, it ultimately improves your business’s creditworthiness. You can get discounts and save money on the payments due by settling the balances within the discount period.
It will not only help to increase your creditworthiness, but you also avail discounts as early payers.
Nothing in this world has all flowers and no thorns. Similarly, factoring is a very suitable solution for many businesses, but it will have its own downside. The most prominent one is that you do not get the full settlement of the invoices. You have to incur a cost for collections.
However, the advantages of factoring overcome its downsides. Hence making it an ideal solution for the businesses looking for instant cash flow without hurting their financial health by borrowing money.