How Does Receivables Finance Work?

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Accounts Receivable Factoring: The Secret to Steady Cash Flow

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Cash Flow Factoring Accounts Receivable For Cash Flow | 7 Park Avenue Financial

 

 

Transforming Business Cash Flow with Receivable Factoring

 

 

Understand the intricacies of AR finance because this article offers actionable insights to maximize your cash flow

 

 

Introduction to AR Finance 

 

Accounts receivable AR Finance isn't as much a 'secret strategy' as opposed to a method to turn your company sales into a virtual cash flow machine; in effect, past obstacles of cash flow have now become a working capital/cash solution.

 

The Importance of Cash Flow

 

You only have to look at some 'search engine' stats to find that thousands of Canadian businesses search every day for what they hope is valuable real-world assistance around their business financing needs.

 

From early-stage companies to mature medium-sized and even larger corporations ... it's always about unlocking cash flow in their sales and receivables.

 

Debunking Misconceptions and Concerns  

 

When clients of 7 Park Avenue Financial talk to us about their financing challenges, we've found it is easy. Clients can be forgiven for getting bogged down in such issues as the cost of this financing, how it works, and even more importantly, dispelling what they may have heard about 'factoring' and 'invoice discounting'.

Business owners and their financial managers are of course, all for a 'good thing'; and they want to know how accounts receivable financing works, as well as wanting to avoid the pitfalls and negative perceptions that come with this method of cash flow finance.  

 

 

Comparison with Other Financing Methods: 

 

 

Factoring stands out distinctly when compared to traditional financing options like bank loans or lines of credit, as well as other alternative financing methods.

 Cost:

 


        Factoring: Generally, the factoring fee might be perceived as more expensive than traditional financing, with fees typically ranging between 1-5% of the invoice amount, depending on various factoring companies' view volume, industry, and the creditworthiness of the business's clients.

Bank Loans & Lines of Credit:

These often come with lower interest rates than factoring, especially if the borrowing entity has a good credit history. However, there are often additional costs, such as origination fees, service charges, and potential penalties.

Alternative Financing: Methods like merchant cash advances or peer-to-peer lending might have varying costs, sometimes higher than traditional loans, depending on the risk assessment of the business.

Flexibility:


Factoring: Offers high flexibility as it's based on the business's sales. As sales grow, the amount of financing available generally increases. Plus, businesses can choose which invoices to factor.
Bank Loans & Lines of Credit: These have set limits. While lines of credit offer some flexibility in terms of when and how much to borrow, they still have a cap. Loans provide a lump sum, which must be repaid according to the agreed-upon schedule.

Speed:


Factoring: One of the fastest ways to get financing. Once set up with a factoring company, businesses can often get cash within 24-48 hours of submitting an invoice.
Bank Loans & Lines of Credit: The approval process can be lengthy, sometimes taking weeks or even months, especially if it's the business's first time borrowing.

Qualification Criteria:


Factoring: Mainly based on the creditworthiness of the business's clients, not the business itself. This can be beneficial for startups or companies with limited credit history.Bank Loans & Lines of Credit: Require a thorough credit check of the business and often its owners. Collateral might also be necessary.
Alternative Financing: Criteria vary widely. Some methods might focus more on business performance than credit history.

 

Financing Challenges for SMEs

 

We're focusing our discussion here on smaller and medium-sized firms; safe to say that larger corporations have access to a lot more financing possibilities in the realm of traditional bank financing. Some firms that are public companies can utilize working capital strategies and business funding that SME (small to medium-sized) companies can't access.

These smaller firms, which of course, make up a huge part of the Canadian business landscape, have to rely on their internal cash flow management as well as utilizing any external finance they can access to fund ongoing operations, growth, and working capital.

The worst irony in business finance may be that many companies have to give up growth prospects simply because they can't access external business capital. That might mean new clients, new markets, foreign expansion, new product lines, etc.

 

 Understanding Cash Flow Factoring 

 

What is Confidential Cash Flow Factoring / How Does It Work

 

Cash flow factoring of accounts receivable is the ongoing sale, in whole or in part, of your sales invoices as you generate them and deliver products and services to your customers.

 

The invoices are purchased at 1-2% % discount from your company, and you receive cash, 99% of the time, the same day, for those sales. So, in effect, all your sales now fuel that cash flow machine we spoke about previously.

 

So far, so good, right? Where complications arise, especially in Canada, is the fact that this type of financing requires your client to be notified of the process, directly or indirectly, and payments are required to be forwarded to your factoring finance firm.

 

Canadian business, in our eyes, is reluctant to involve their customers in their internal financing policies and challenges. As a result, many firms are skeptical of entering into accounts receivable finance in this manner.

 

Under non-notification accounts receivable confidential financing the company bills and collects its own receivables, while achieving all the benefits of traditional factoring.

 

 

 

 

Customer Perception and Business Relations

 

Common Take: Factoring, especially if not confidential, might sour the relationship with customers as they might perceive the business to be in dire financial straits.

Uncommon Take: Smart businesses can frame factoring as a proactive financial strategy that ensures continuous and robust operations without any disruption. Instead of a sign of weakness, customers might see it as a mark of a business that plans ahead, ensuring that product or service delivery is never compromised due to cash flow issues.

 

The Best Solution In Financing Sales

 

Is there a solution? We told you there was a breakthrough called Confidential Invoice Discounting!

This type of financing comes at the same cost as 'old school' factoring, and allows you to bill and collect your receivables!

Your company gains all the benefits of that cash flow factoring machine we've turned your company into. This type of facility can easily be a part of a non-bank business line of credit known as an 'ABL' - that's an asset-based line of credit that allows your company to have a credit line that functions like bank credit lines.

Let those competitors, customers, and vendors remain precisely where you want them to be, outside your financing strategies and challenges! Let your competitors try and figure out how you're doing so well in both growth and profits.

 

Types of Factoring:

 

Factoring, a financial solution for businesses to improve cash flow, comes in various forms to cater to specific needs. Recourse and Non-recourse Factoring are two primary classifications. In Recourse Factoring, the business selling its invoices remains liable if the debtor (the business's customer) fails to pay.

 

This means that if the customer doesn't settle the invoice, the factoring company can "recourse" to the original business to recover the funds, often making this option cheaper since the factoring company's risk is lower. On the other hand, Non-recourse Factoring frees the selling business is when the factoring company assumes bad debt and collection risk.

 

If the debtor fails to pay, the factor absorbs the loss, making this a safer, albeit often more expensive, option for businesses.

 

 

Key Takeaways

 

Factoring is a financial transaction in which a company sells its accounts receivable (invoices) to a third-party factoring company at a discount. This is done primarily for the purpose of obtaining immediate cash flow.


Process:


Invoice Sale: Businesses deliver their products/services to their customers and then sell these invoices to the factoring company.
Immediate Cash: The factoring company provides the original business with around 80% to 99% of the invoice amount upfront.

Collection and Final Payment: The factoring company is then responsible for collecting the full invoice amount from the customer. Once collected, they will pay the remaining balance to the original business, minus their fees (typically 1-2%).

Confidential Invoice Discounting:


This is a variant of factoring where the customers aren't aware that the invoices have been sold. The business still manages the sales ledger and collects payments from customers, making it confidential. The benefit is that relationships with customers remain undisturbed, and businesses can still get immediate financing.


Benefits:


Immediate Liquidity: Businesses get access to immediate cash instead of waiting for clients to pay invoices, aiding in consistent cash flow and capital for investments or operations.


Risk Transfer: The risk of non-payment or late payment can be transferred to the factoring company, depending on the agreement.


Challenges:


Cost: Factoring can be more expensive than traditional forms of financing due to the fees involved.


Customer Relationships:

In traditional factoring (non-confidential), customers are made aware that invoices have been sold, which may affect business relationships.

 

Conclusion

 

Call 7 Park Avenue Financial,  a trusted, credible, and experienced Canadian business financing advisor with a track record of business finance success, putting your firm into a proper Receivable finance facility, allowing you to reap the benefits of cash flow invoice financing.

 

 

   

  

FAQ: FREQUENTLY ASKED QUESTIONS PEOPLE ALSO ASK MORE INFORMATION     

 

What is factoring in the context of accounts receivable?

It's a process where businesses sell their accounts receivable (invoices) to an accounts receivable factoring company at a discount to obtain immediate cash flow.

How does Confidential Invoice Discounting differ from traditional factoring?

Confidential Invoice  Factoring  / Discounting allows businesses to receive financing without notifying their customers, ensuring the sales and collection process remains undisturbed.

What percentage of the invoice amount can a business typically receive upfront?

Businesses usually get a cash advance between 80% to 90% of the invoice value amount immediately when factoring - The factoring company pays you the remaining balance, less a factoring fee when the client pays.

Are there any risks or downsides to factoring accounts receivable?

One challenge is the cost, as factoring can be pricier than other financing methods. Also, in traditional factoring, customers are informed of the invoice sale, which might affect relationships.

Why would a business choose factoring over a traditional bank loan?

Factoring provides immediate liquidity, transfers the risk of non-payment, and doesn't add debt to the balance sheet, making it an attractive option for many SMEs.


Are there different types of factoring beyond Confidential Invoice Discounting?

Yes, besides Confidential Invoice Discounting, there's recourse and non-recourse factoring. Recourse factoring means the business is liable if the invoice isn't paid, while non-recourse transfers this risk to the factoring company.

Is it common for all industries to use factoring as a financing method?

Factoring unpaid invoices is more common in industries with long invoice cycles like manufacturing, textiles, or wholesale, but any industry can leverage it based on their cash flow needs to finance commercial business-to-business accounts receivables.

Does factoring impact a business's credit score or rating?

Factoring receivables typically doesn't affect a business's credit score directly as it's not a loan, but it can improve the company's financial health by boosting liquidity.

Can a startup business use factoring for financing?

Absolutely! Startups often use factoring since they may not qualify for traditional bank loans due to a lack of credit history. Accounts receivable factoring works for any company that has commercial invoices to finance.

By utilizing accounts receivable factoring, companies can offer more adaptable payment options and decrease the time and resources needed to receive customer payments from customers and fund daily business operations.

How long does the factoring process typically take?

The initial setup with many factoring companies might take a week or two, but once established, businesses can usually receive funds within 24 to 48 hours of invoicing after a factoring agreement and factoring fees / receivable factoring cost are established.

 

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