Accounts receivable (AR) financing, commonly referred to as factoring, is a type of business financing where companies or individuals sell outstanding balances or receivables to a factoring company at a discount. The factoring company will provide your company with quick access to better cash flow in return for assuming the risks involved on the receivable. It is important to note that AR financing is not a loan. According to tabbank.com, it is a factoring agreement which you need to make sure of.
Important Parts of a Factoring Agreement
Prime rate. A prime rate is a varied interest amount, so it is important that you know how to calculate this. This is an integral part of AR financing which you have to make sure that the deal contains.
Purchase date. The value assigned for each invoice will vary depending on its age or the purchase date. The more current the invoice, the higher the amount you will get for it. Factoring companies will no longer finance accounts receivable that are over 90 days old because they consider these late.
Terms of agreement. It is vital that you check the length of the agreement. You need to assess if your business needs a long-term or short-term agreement.
Pros and Cons of AR Financing
AR financing is a type of unsecured business financing that does not need any collateral nor requires you to give up part of your ownership of your business. This is a great option for small-business owners who cannot qualify for a conventional loan because it does not look at the credit history of the business. Instead, factoring companies base your qualifications on the credit worth of your customers. Although, that could also work against you, especially if you don’t have enough credit-worthy customers.
However, while it sounds great, it does come with some drawbacks you need to be aware of, such as its higher rates. Also, most agreements come with lengthy contracts. In most cases, you don’t need to be locked in a factoring agreement for several years, so you need to check your contract and negotiate for a shorter term if possible.
There is no such thing as a perfect business financing solution. Each one has its own advantages and disadvantages. You just need to be aware of them to make an informed decision.