Accounts receivable financing, also known as factoring, can be simply defined as an asset financing arrangement in which the receivables are used as a collateral. This serves as method where a company can free up or ideally leverage the capital which is in otherwise stuck in useless paper or in the receivables.
By factoring or selling the receivables, the risk associated with it will also get transferred therefore reducing the company’s burden thus enabling it to focus on the profit making activities. Account receivable financing proves to be of great help as it can provide the additional funding a company might need.
Any kind of business requires consistent money flow to cover certain needs and whenever there is a seasonal demand or short term cash is needed, immediate flexible cash is called for various purpose like payroll payment and buying more inventory. This is exactly where factoring becomes of help. Factoring gives your business the ability to access quick money, sparing the need for selling equity in your firm. Research shows that compared to equity, lending is a lot less costly than selling a part of the company.
Accounts receivable financing can be a lot more beneficial to your business in other ways besides just cash. It can create more valuable time which lets you provide better customer service as well as generating new business. This kind of financing can really help reduce the payment turnaround time therefore making better money floe for your business.
However, the question is whether every business requires this accounts receivable financing is very debatable. The need of factoring may differ from business to business and it mainly depends on the size of the business and as well as its various requirements. For example, in most importing companies and logistics firms, the amount of receivable would be large enough but the factoring process might not work out. The reason is because their margins tend to be small in such industries. Ideally, if the gross margin of a firm is below 12%, it should analyze and recheck its factoring activities. Generally, a company needs to have at least or above 25% gross margins to be able to easily use account receivable financing as a financing tool. Every firm has its own capital needs and what it needs is a customized receivables financing option which can only be obtained after a through analysis of its needs.