Businesses earn accounts receivables, or AR, from the products they sell or the services they offer when customers are able to pay in installments or have been forwarded a line of store credit. These are like invoices, or receipts, in a way. Let’s say your business does home remodeling, and a client comes to you with a large job but wants to pay in installments. You do the job, and then have an agreement with that customer to receive payments on time when they are due. Now let’s say your business wants to purchase additional inventory, but since you have not yet been paid for the services you provided to customers, you are a bit short on funds. Selling your AR to a factoring firm means you get the cash you need, without disrupting the payment plan of your customers.
How do I get the funds?
Factoring firms will buy your outstanding AR at a discounted price. Obviously, if you keep the AR yourself, you will end up getting more money in the end over an extended period of time – but if you need an advance of cash in one lump sum for business expansion or inventory purchasing this is the best option to consider. Once purchased by the firm, the AR will no longer be part of your books and will be collected upon by the factoring firm. The lump sum you received, however, can be used for any business management you need it for whether it is purchasing a new building, adding inventory or machinery, paying local employees, or hiring outsourced labor.
What about the fees?
Unlike traditional banks that offer business loans, the fee tables with factoring firms is usually very straightforward and easy to understand. The fees are almost always based on the credit worthiness of your customers, not of your business, so even small businesses that have not yet built a high credit rating can be approved for factoring if they have a strong customer base. While the final numbers may vary from firm to firm, once approved you will normally get between 70 and 90 percent of the invoice amount to your business account within a few days of the agreement. The remainder, minus the factoring fees, will arrive later depending on the predetermined length of payment arranged with the customer at the time of delivery for the goods or services you provided.
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