Is Accounts Receivable Factoring Safe?
Factoring is no longer a breakthrough process, rather now a routine. So is accounts receivable factoring safe given the time that it has been around?
Generally yes. Many businesses large and small are actively engaged in factoring, as it accelerates their cash flows and provides additional working capital to sustain or grow the business.
With that said, it is important to carefully evaluate an accounts receivable factoring agreement because of the numerous components involved.
Here are just a handful of tips that helped me. I hope you will find these useful as well.
Know the Difference Between Recourse and Non Recourse
Your factoring agreement will either be with recourse or no recourse.
In my experience, a factoring agreement with recourse is typically more common as this gives the Factoring company the most comfort because you share the risk of customer default with them.
Because you are involved in risk sharing, the agreement generally costs less compared to an agreement without recourse, where the Factoring company is on their own if the customer defaults on their payment.
Which one should you opt for? This depends on your customer’s profile.
If your customer’s usually pay you full and on time, you may want to consider a recourse agreement.
The accounts receivable factoring cost involved in a recourse contract is much lower.
On the other hand, a non recourse factoring agreement option is best when you doubt the collectability of customer invoices.
Whether Factoring companies prefer one over the other heavily relies on the industry you are in and your business’ typical customer profile.
The accounts receivable factoring rates involved in a non recourse agreement are typically higher because the Factoring company bears all risk while you retain none.
Is Accounts Receivable Factoring Costly? Understanding the Fee Structure
A critical component of a factoring agreement is the fee schedule. Make sure you understand what kind of fees are involved (set up, discount rate, etc). Despite speakin to company reps at length, take time to read every single word of the contract.
Don’t be afraid to ask questions as some of the language can be Greek if you are new to factoring. Most importantly, clarify all the potential fines and fees involved in the event of customer default (if you enter a recourse agreement).
For example, some companies may require you to pay what the customer doesn’t within a certain timeline, plus accrued interest and other ancillary charges. Fees are normal, just make sure you understand what they are and when will you be charged.
Understand and Agree Upon the Min – Max Terms
For factoring to be a profitable activity for many companies, a minimum number of invoices or customer accounts receivables must be factored or processed by them monthly. Make sure you understand whether the Factoring company has any such requirements.
Also ask whether there is a maximum invoice requirement. God forbid you have a wonderful month of business and need expedited cash flow. Will you be capped off by the Factoring company after a certain number of invoices?
Make sure these numbers are explicitly stated in the contract.
Get the Factoring Agreement Reviewed by a Lawyer
You didn’t need me to tell you that. I know you know the importance of getting a long term legal and binding contract reviewed by a legal professional before signing it.
The contracts are not too complicated and typically cost a couple hundred bucks at most to have reviewed. It’s a couple hundred bucks well worth spending.
Is Accounts Receivable Factoring for You? My Concluding Thoughts
A factoring agreement is completely safe, so as long as you take your time to understand each component involved before signing it to avoid any surprises.
Whether you enter a recourse or non recourse accounts receivable factoring agreement is up to you, so as long as you understand each and are aware of what exactly you need for your business.
So is accounts receivable factoring safe? I hope you have an increased comfort level after reading this short article.
All the best,