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accounts receivable factoring examples

Accounts Receivable Factoring Examples, Costs, and More

What is Accounts Receivable Factoring?

Factoring insurance for receivables is an agreement with a third party company to purchase accounts receivables at a reduced amount of the face value of the invoices. The factor provides a cash advance ranging from 70% to 90% of the invoice’s value. When the invoice is collected, the factor returns the balance of the invoice minus their fee. These costs may range from 1% to 10%, based upon a variety of components. Some factoring services will assume the risk of non-payment of the invoices they purchase, while others do not.

Is factoring receivables a good idea?

AR factoring can be a good idea if your company is having cash flow issues and needs to collect on receivables quickly. Receivables factoring allows your company to apply the receivable funds toward future projects, payroll or other operating expenses without having to wait for payment of invoices.

However, while receivables factoring can be beneficial in the short-term, there are long-term costs to consider. You pay fees ranging from 1% to 5% for the service, even if the receivable is paid in full within 60-90 days. The longer the receivable remains unpaid, the higher the fees. Payment guarantees aren’t always available, and if they are, they can double factoring fees to as high as 10%. For small businesses with smaller receivables, this may not seem like a lot. For larger companies, there is the potential to lose between $10,000 to $100,000 for every $1 million in factored receivables.

In addition, receivables factoring poses risks to your long-term customer relationships:

  • You lose control of your customer relationships in a factoring agreement.
  • The factor that owns accounts receivable manages all credit matters involving those customer relationships.
  • You have to go through the factor in order to contact a customer.

How Does Factoring Trade Receivables Work?

Business accounts receivable factoring starts when you’ve successfully provided the goods and services to a customer and invoiced them. You can then sell your invoice to a factoring company. Here’s how AR factoring works:

  1. You sell the invoice to the factoring company.
  2. The factor funds your company with an advance ranging from 70% to 90% of the invoice amount.
  3. When the customer pays the invoice, your company gets the remaining balance of the invoice, minus the factoring fee.

The business accounts receivables factoring process has its advantages, but it also comes with a cost.

Recourse vs Non-Recourse Factoring

There are two types of invoice factoring: recourse and non-recourse. Before you choose to do business with a factoring company, it is important to know the difference between the two options.

Recourse Factoring

Recourse factoring is the most commonly used form of AR factoring. With recourse factoring, if a customer fails to pay, you are responsible for buying back the invoice from the factoring company. The factor tries to offset the risk of non-payment by assessing the customer’s creditworthiness and applying collection calls between 40-90 days after the invoice was sent. If the factor is unable to collect on the invoice within 90 days, the factor may “recourse” the invoice back to you. You may then need to use a collection agency to collect on the invoice. In the meantime, you’ll need to pay the factor back.

Non-Recourse Factoring

Non-recourse factoring carries a higher risk and is generally used less frequently. With non-recourse factoring, the factor takes responsibility for the invoice, even if they are unable to collect. Often, non-recourse factoring is only applied if the invoiced company files bankruptcy. In addition, fees for non-recourse factoring are much higher than those for non-recourse factoring.

For companies looking to avoid the risks of recourse factoring and the higher costs of non-recourse. factoring, trade credit insurance provides an attractive alternative.

The Difference Between Factoring and Credit Insurance

Credit insurance is a compelling and affordable alternative to accounts receivable factoring. Credit insurance can strengthen both cash flow and strategic decision making.

Insuring accounts receivable with credit insurance:

  • Keeps your company connected to your customers.
  • Creates more predictable cash flow.
  • Allows you to conduct business without interference and with approved credit for your customers.

Let’s look at a real-world example of the choice between credit insurance and factoring.

A company with $5 million in annual sales transactions choosing between purchasing credit insurance and selling its accounts receivable to a factor will see a significant difference in costs.

The Cost of Credit Insurance

Credit insurance covering $5 million in accounts receivable generally conservatively costs may cost between 0.25% to 0.50% of the insured amount, or between $12,500 and $25,000.This ensures that cash flow remains uninterrupted – if the invoice is not paid, the credit insurer covers the loss.

Credit insurance costs range from:

$5,000,000 x 0.25%, or $12,500

to

$5,000,000 x 0.50%, or $25,000

The Cost of Factoring Receivables

The fees involved in selling $5 million in accounts receivable to a factor are generally one percent of the total amount, or $50,000.

This amount does not provide any payment guarantees for the sold accounts receivable and such guarantees are not always available.

If the factor does offer payment guarantees, the cost of those guarantees is another one percent of the value of those accounts receivable. This adds another $50,000 to the cost of factoring and brings to the total cost with payment guarantees to $100,000.

Factoring only:

$5 million in accounts receivable x 1.0%, or $50,000

Factoring with payment guarantees:

$5 million in accounts receivable x 2.0%, or $100,000

Choose Credit Insurance Over Accounts Receivable Factoring

The numbers tell the story. Leverage credit insurance for the sake of your business to preserve your bottom line, protect your company from the risk of non-payment, and maintain your customer relationships.

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