Factoring insurance for receivables is an agreement with a third party company to purchase accounts receivables (AR) 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 services will assume the risk of non-payment of the invoices they purchase, while others do not.
What is Accounts Receivable Factoring?
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. It allows your company to apply the receivable funds toward future projects, payroll or other operating expenses without having to wait for late payment or unpaid 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 the 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 an 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 AR 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 it works:
- You sell the invoice to the factoring company.
- The factor funds your company with an advance ranging from 70% to 90% of the invoice amount.
- When the customer pays the invoice, your company gets the remaining balance of the invoice, minus the factoring fee.
The business AR 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
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
Non-recourse factoring carries a higher risk and is generally used less frequently. With it, 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 recourse factoring.
For companies looking to avoid the trade risks of recourse factoring and the higher costs of non-recourse. factoring, trade credit insurance provides an attractive alternative.
The Difference Between Factoring and Trade Credit Insurance
Trade credit insurance is a compelling and affordable alternative to AR factoring. Trade credit insurance can strengthen both cash flow and strategic decision making.
Insuring accounts receivable with trade 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.
Trade Credit Insurance vs Factoring Receivables Example
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 Trade Credit Insurance Over AR 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.
Allianz Trade is the worldwide leader in export credit insurance and business debt collection, offering expert solutions such as account receivable management, trade credit, credit control, bad debt, bad debt recovery, debt collection & recovery, business risk, trade risk, industry risk, country risk rating, credit management, cash flow management, collect overdue payments and late payments. Our mission is to help customers globally to manage trading risk, trade wisely and develop their business safely.
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What is Export Credit Insurance? Export credit insurance helps companies remain competitive by offering open terms when letters of credit or prepayment may have previously been the only safe way to do business. In fact, foreign companies buy an average of 40 percent more when they are offered open terms, according to the World Trade Organization. Export credit insurance providers protect your sales from political risks, including import/export changes and foreign government intervention. Few companies can effectively compete without extending trade credit to their buyers. For exporters, getting accounts receivable insurance levels the global playing field. Working with new countries means dealing with new cultures and new opportunities to access new markets and customers. Businesses must know to manage the associated credit risks that come with exporting products or services.