What Is Accounts Receivable Factoring(ARF)

Ashish

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Do you have accrued so many unpaid customers? Who needs urgent settlements of their account payables? And you are a small business owner. Don't worry! Unpaid invoices are part of running businesses. So here comes the solution, you can use account receivable factoring.

Account Receivable Factoring helps companies settle their unpaid customers. It lets companies provide the right to use cash by selling account receivables invoices. The Account Receivable Factoring service provider is called the "factor" who collects payment on the receivables from the business owner's customer.

Importance of Account Receivable Factoring to SME?

When it comes to deciding factoring receivables, small business owners also need advice on what is factoring? and how does it work? For example, what is the cost to choose factoring services as an option to settle an unpaid customer account? 

Small businesses require substantial advice while running their business at startup and running phases of business. BizReport is an authority to provide you with advice on your business startup services. It guides you over where to invest; the cheapest LLC formation services offer you business name generator services and hot news on business. It is a reputable source of information in business, loans, banking, and trading.

Is Account Receivable Factoring a Loan?

Account receivable factoring is not technically a loan; it is actually invoice factoring, allowing companies to quickly access the cash they have earned.

How Does Factoring Work?

Factoring works in the cycle where a business owner sells his account receivable to a factoring company. Then, the factoring service provider collects the amount on receivables from the company's client or customer. 

How Does Factoring Benefit Businesses?

Business owners like to use factoring services when running short of cash. They want to receive some money quickly rather than wait for their account receivables' maturity. Factoring helps businesses collect some money and pay their business liabilities on time. Factoring allows businesses to free up capital that is stuck in the form of account receivable. It also shifts the risk of default attached with account receivable to factoring service providers.

What are types of factoring?

Account receivable factoring is of two types:

  1. Transfer with recourse
  2. Transfer without recourse

Transfer with recourse

Transfer with recourse factoring allows factoring service providers to demand money back from the business owner that transferred receivables if those receivables are uncollectible from customers.

Example:

A  Business Owner/Company transfers $800 million of receivables, with recourse, for proceeds of $750 million and $ 50 million holdback. Later on, the factor can collect receivables of $490 million ($10 million receivables uncollectible)

Title Account Title Debit  Credit

xxxxxx Short term Debt $750, 000,000

xxxxxx Due from  the factor hold back $50, 000,000

xxxxxx Cash  $800,000,000

A transfer without recourse factoring

Transfer with recourse factoring allows factoring service providers to bear the risk of uncollectible receivables. Using factoring "transfer without resource", the business owner has no liability for uncollectible receivables.

Example:

A Business Owner/Company A transfers $800 million of receivables, without recourse, for proceeds of $700 million. Therefore, the journal entry would be as follows:

Title Account Title Debit  Credit

xxxxxx Cash  $800,000,000

xxxxxx Interest expense $100, 000,000

xxxxxx Short term Debt $700, 000,000

How much Does Account Receivable(AR) Factoring Cost?

Generally, factoring companies set prices after the valuation of the account receivable invoice. The factoring services providers offer flat rates and variable rates. If the account receivable matured soon, the company would charge the flat rate. However, suppose the account receivable will mature after a long period. In that case, the factoring service provider may offer variable rates charging more for late recoup of payment. 

Other factors that affect the cost of services include the industry the company is in, the quality and creditworthiness of the company's customers, and the volume of receivables to be factored.

How Does a Business Qualify for Account Receivable(AR) Factoring?

To qualify for Account Receivable Factoring services, Business owners need to develop invoices that provide price, sales, and payment timelines. The invoice for work in progress does not qualify for receiving factoring services. 

Secondly, a registered business qualifies for an account receivable factoring service. A person is not eligible for this service as the owner's credit score doesn't decide the creditworthiness in Account receivable factoring.

Does Account Receivable(AR) Factoring differ from account receivable financing?

Accounts receivable financing and Account Receivable(AR) Factoring are not similar. Account Receivable(AR) Factoring is not a loan. It is more expensive than financing because the factoring company collects the invoice. 

Accounts receivable financing is a type of loan. It uses an unpaid invoice as collateral.

Conclusion

In conclusion, we many say that Account receivable factoring is one of the best options available to fulfill running finances needs. This is because factoring allows businesses to free up capital stuck in the form of Accounts receivable.

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