How Does Factoring Work?

If you’re in need of financing, there are a number of alternative lending options that can provide the capital you need. One of these options is factoring, also known as accounts receivable financing. This type of financing can be especially helpful for certain types of business structures, but can initially seem complicated. Here’s a breakdown of how factoring can work for you.

1. Accounts Receivables

If your customers send payment 30 days or more after receiving your products and services, you no doubt have accounts receivables. This particular business structure means you don’t have immediate access to funds owed, and may not receive payment at all. This can create financial strain and limit your ability to run your business to your satisfaction.

2. Debts Become Assets

Factoring takes these liabilities and turns them into assets. A financial institution or lending agency essentially “buys” your accounts receivables. They then become responsible for collection of payments and the associated risks. Unlike most loans, this kind of financing doesn’t rely on your credit history. Instead, it’s your customer’s credit that plays the biggest role.

3. Faster Cash

With this type of financing, you are paid upon exchange of accounts receivables, and therefore have immediate access to capital. The initial amount is generally determined by the customer’s likelihood of paying, and is a percentage of the total amount due. Once the customer has paid in full, you may receive additional funds covering the difference between the initial payment and total amount, minus a service fee charged by the financial institution or lending agency. The fee is only a small percentage of the total amount and can be well worth the cost. Having funds available when you need them can allow you more opportunities to expand your business or make needed changes you otherwise wouldn’t be able to consider.

4. Lower Risk

The greatest risk with accounts receivables is that you won’t receive payment at all. Since you’ve already delivered on your promise with services or products, this can be a difficult loss, especially if you’re a smaller business. When you choose this type of financing, the financial institution or lending agency takes on that risk instead. These companies are usually much larger, so if the customers don’t fulfill their payments, they’re able to absorb the loss and simply write it off as the cost of doing business. This loss no longer affects you as drastically since you’ll still have partial funds from the initial exchange of accounts receivables.

If you’re a business that relies heavily on accounts receivables, factoring may give you the advantage you need to make your business thrive. With no collateral necessary, this type of financing can take a liability and turn it into a financial resource.

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