What Is A/R Financing Based On?
A business that extends credit to the purchaser of merchandise or services for which it has already paid ties up a significant portion of its working capital in accounts receivable. To improve its short-term cash flow, a business may turn to a service to finance its accounts receivable and provide immediate cash to the business. Services that provide accounts receivable financing advances are called factors, or factoring companies.
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Recourse
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Factoring companies offer two different types of financing: recourse and non-recourse. With recourse financing, the factoring company is advancing a portion of the billed invoice to the business. If the customer does not pay the invoice within a certain time frame, the selling company is responsible for the amount the factoring company has advanced and must pay it back. With non-recourse financing, the factoring service takes on full responsibility for the invoice, including all the actions necessary to collect the invoice that it may pursue.
Quality of Receivables
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A factoring company bases its decision to provide factor financing based on the quality of the receivables that the business holds. Often, a factoring service will examine the history of a business's accounts receivable to determine the aging of the accounts and the average payment performance of the customers. As part of the quality assessment, the factoring company may offer the business other accounts receivable services, such as invoicing and credit evaluation that can help cash flow. Most factoring companies will not take on sub-standard accounts with poor payment history or credit.
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Type of Industry
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Some factoring companies provide services for all different types of businesses, depending on their accounts collection histories. Other factoring services provide only financing for certain business sectors, such as medical providers. A factoring company may specialize in industries with a history of accounts receivable problems, but assess higher fees or demand more control over the collections process in exchange for the increased risk.
Factoring Charges
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Factoring services are not billed like typical loans with an interest rate. Factoring companies often charge a percentage of the total bill, from 2 percent to 10 percent of the total invoice. The factoring service will advance an amount of an invoice, typically 80 percent to 85 percent, when it receives a copy of the invoice. After the customer pays the bill, the factoring service will pay the company the remainder of the invoice, less factoring charges and fees for any other services rendered. Against the possibility of being given only the business' slower paying customers, the factoring company may demand all of the business's receivables be handled through it.
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