Selling your accounts receivable is known as factoring. Factoring is one of the oldest forms of financing known to modern civilization originating in the ancient
Factoring has become a mainstream way for small businesses that sell products or services to other businesses to finance their growth through sale of A/R.
There are a few things that companies using factoring services should always keep in mind.
- Once you have sold a particular invoice to a factor, you are usually not allowed to cash a check for payment for goods or services sold under that invoice. The factoring industry calls this practice conversion and it is the fastest way to loose your ability to finance your accounts receivable. Nearly all A/R financing companies want payments to come to them after they have purchased invoices from you. Some factors will warn you the first time you convert payment then stop doing business with you on the second time. Some factors will charge you a fee (often 15% of the amount of the invoice) for converted invoices. The best course of action if you receive a payment from a customer that should have been directed to your factoring company is to call them and ask them for directions. Most will ask you to forward the payment directly to them.
- Most factoring agreements require you to sign a submission form when you submit an invoice or batch of invoices for funding. Usually you are certifying that the goods and services have been delivered, that there is no dispute with the customer over any issue that might affect payment, and that the amount of the invoices are exactly what you expect the customer to pay. Fraud is a big risk for companies that finance A/R, so they will verify either all or part of every batch. If you want them to spend less time verifying invoices make sure and submit copies of all supporting documentation from your customer. For example, if you ship via common carrier, include a copy of the bill of lading. If you have a purchase order, include a copy. If your customer has signed a written acceptance showing that the goods and services have been delivered, send that. The more credible documentation you send to the factor when you fund it, the less invoices they will phone verify on a go forward basis.
- If your factor will allow you to “age” your invoice a few days to several weeks before you sell it them, you will save considerable discount fees. For example, if your factor is charging you 2.5% for the first 30 days or any part thereof, and 1.25% for each 15 days thereafter, you would be best off selling the factor an invoice for a customer that customarily pays in 45 days two weeks after you invoice them. That way the invoice gets paid within the 30 day period and you avoid an extra 1.25% fee. Not all factors will let you age your invoices but some will and if you factor with one that does, take advantage of the savings if your cash flow allows.
- Make sure and reconcile each invoice and batch of invoices every month. Nearly all factors reserve 20-25% of every invoice at the time they purchase it. As invoices pay, the factor releases the face value of the invoice minus any anticipated fees they assume you will pay. They debit your reserve account on the last working day of the month for any fees you owe them. They should Email a set of reports to you right after month end closing. Reconcile each invoice and make sure the fees charge on the invoice are all correct and that any other fees such as wire fees or ACH fees are being charged at the rate stated in your agreement.
- Nearly all factoring agreements have a term. Many are one year, some are multiple years. A few of them are month to month. Nearly all factoring agreements require 30 days or more notice of your intent not to renew the agreement at the end of the agreement period. Before that date has past, plan on renegotiating the factoring fees if they higher than you think they should be given your usage of the service. Shop around with other factors. Nearly every factor that believes they will loose a good customer because they are unhappy with the fees will lower them to keep you as a customer. Just remember your leverage is lost if you wait until the contract automatically renews for another year.