Small businesses may opt to undertake a process known as factoring which impacts their accounts receivable, or AR process. There are many benefits for businesses for undergoing An ar factor, but not every business will benefit from it. Here are some of the ways in which an AR factor can have a significant impact on your business.
What is AR Factoring?
When a company has their accounts receivable factored, the risks associated with collecting the receivable is transferred to the factor. A factor is a third party who will enter into the arrangement and assume the collection risk associated with the receivables in exchange for a discounted price on the receivables. The exact amount of the discount will depend on several factors but most notably on the customers themselves of the company and how likely they are to pay.
In the typical arrangement, a company will sell a product to a customer and then transfer their receivable to a factor. The factor will pay the company in a short term period for the receivable. Then, a factor will then attempt to collect a sample receivable of $100 and pay $96 for the right to do so, if there is a 4% factoring rate. If the customer defaults, the factor loses out and the company is not liable for the receivable or reimbursing the factor.
What role does AR factoring play for a business
AR factoring provides some notable benefits for a business. One of the major benefits is that it provides stable cash flow for the business and helps young organizations to gain the experience and expertise of a factoring company for collecting outstanding debt. This means that a factor typically does a better job collecting receivables than those who use a factor and may recover more than a business would write off or incur in collection processes, including the credit card transaction fees that a company incurs when collecting balances.
Collecting outstanding receivables can be a huge distraction for a company, particularly when a business is reliant on collections for meeting their payroll and other short term obligations. Management often needs to get involved and the end result is a big distraction for the company and its management. A factor relationship allows the management to focus on those things that are truly important for the company, such as growing in the right way and hiring the right people. Collecting money can be a distraction for a company and using a factoring solution can eliminate this headache and allow the company to focus accordingly.
The fee that is charged to collect balances represents lost earnings for a company and a fee for using a factor. This is an added cost for a company that eats into their margins. As such, a company needs to balance out these benefits and costs when choosing to use a factor or not.
Which businesses will benefit from an AR factor and which will benefit from having their own Internal AR Process
Not all businesses should use an AR factor solution. Businesses don’t universally benefit from doing so and detailed consideration of the facts and circumstances surrounding the business can impact the decision.
Factors that make using an AR factor a good idea:
– unpredictable cash flow
– a limited in-person accounting team
– uncertain future
– significant potential for a cash investment to grow business
– the challenging customer base for paying debt
Factors that make using an AR factor a bad idea:
– return customers who make timely payments
– advanced and stable business model with predictable cash flow
– lack of investment opportunities in market
– stable organization and management
– developed accounting team with in house collections specialist