Accounts receivable factoring can give businesses a shot in the arm by providing much-needed working capital.  The purpose of this article is to explain how the factoring process works and what types of businesses qualify for this type of financing.  Although factoring is a very flexible was to accelerate a company's cash flow, there are some guidelines that must be followed.

Goods or services must be completed and accepted by the customer

The goods or services invoiced must be received in good order and complete by the customer without the likelihood of set-offs.  Progress billings cannot usually be factored.  In other words, companies can't get cash advances on a contract that is not yet completed.  If there is a portion of the contract that has been accepted as complete by the customer, then the invoice can be factored.  For example, a manufacturing company contracts with a  customer to produce 5,000 units in a year.  In the first month, they manufacture, ship, and invoice 500 units of the product to the customer.  Assuming the goods are considered acceptable, the invoice can be factored.  Conversely, let's say a construction company has a contract with a municipality to build a water tower.  The acceptance of the final product won't occur until all components of the water tower is completely installed and operating.  This would not be a situation in which factoring could be employed.

Factoring clients must have creditworthy customers

A variable that is of utmost importance in the invoice factoring relationship is the creditworthiness of the client's debtors.  LIke any financing source, factoring companies are sensitive to a greater than normal amount of risk.  When a factor advances 80% of the invoice amount to a client, they must be reasonably assured they will recoup those funds by the customer paying the bill in a timely manner.   Factoring companies investigate the credit history of each debtor, which allows them to set limits on the amount the amount they will advance.  An overall composite of the creditworthiness of the client's customers also effects the advance rate as well as the fees that will be charged.  One advantage to invoice factoring is the additional services that are provided.  One of them is credit screening, which helps clients choose the right customers to deal with.

Receivables factored must be associated with another company

Invoice factoring is defined as the sale of a company's accounts receivable at a discount for immediate cash.   The receivables must be from another business, not an individual.   For example, a retail clothing store would not be a candidate for factoring since they sell to individuals.

Payments must be received within 90 days

Accounts receivable factoring is predicated on the idea that the A/R is short term in nature.  Most factoring companies expect payments to received within 90 days.  If an invoice goes unpaid beyond that time frame, they usually expect the client to either pay back the advance they received, or supply a current invoice to replace the unpaid amount.

Factoring helps accelerate a firm's cash flow and provides working capital for growth and stability.  It's important for the client to understand the various components of what is expected from the factoring company at the outset of the relationship.