Many new business owners are sort of surprised when they learn that they can sell their receivables, or invoices, to a factoring company. It may be a difficult concept to understand, because receivables are not actually a tangible item. But not to worry, we’re going to go over how a factoring company buys accounts receivables from their customers.
What Does the Transaction Include?
The answer to this question can vary depending on the exact type of factoring that is being used. For instance, in a non-recourse factoring arrangement, the credit risk of the customer is sold along with the receivable. This means that you are not responsible for paying back the factor if your customer doesn’t pay the invoice.
Related: The Guide to Non-Recourse Factoring
But if you are selling receivables to a recourse factoring company, you are not transferring the credit risk. This means that if your customer doesn’t pay, the factoring company will come back to you for payment. Read more about recourse factoring.
The Process of Selling Invoices to a Factor
For the most part, the actual transaction process is similar between the many different factoring companies. In most cases, it can be completed in 24-48 hours. This makes factoring an appealing solution for cash flow emergencies.
Applying for Factoring
When a factoring company is preparing to buy invoices from a business, the first step is to have a completed application. They are usually pretty short, and include some basic business information such as:
- Owner’s information and history
- Average monthly revenue
- Age of receivables
- Who the customers are
- How much is being factored
After an application is received, a factor will usually perform some due diligence to protect their interests.
The Due Diligence Period
Before purchasing accounts receivables, factoring companies will review a customer’s credit worthiness, and will also verify that the invoices they are buying are actually valid and still outstanding.
Notice of Assignment
Once the due diligence period has been concluded, a factor must send a Notice of Assignment (NOA) to the customers who’s invoices are being purchased. This is simply a notification of the factoring company’s interest and involvement in the collection of the receivables.
Now an accounts receivable factor is ready to buy receivables from a business. If many invoices are going to be bought that involve the same customer, the process doesn’t need to be repeated. Because the credit checks and NOA have already been performed, it is simply a matter of verifying a new invoice to ensure prior to buying it. From this point on, factoring transactions can occur in as little as 24 hours. Sometimes, they can even happen the same day.
What You Should Remember
The process that a factoring company undertakes to qualify a client prior to purchasing their receivables varies slightly between companies. Furthermore, the type of factoring a business is seeking can also affect this process slightly. Knowing the intricacies between the different types of invoice factoring can help a business know what exactly to expect.