Working Capital Financing 101: Definition, Types & Tips
What exactly is working capital financing? What are the methods of financing working capital? We have the answers for you.
Receivables factoring is when you sell your outstanding receivables to a factoring company.
It is an arrangement of sale and purchase, not lending and borrowing. As the factoring company buys your receivables, it will be responsible for collecting money from your customers too.
Here is how receivables financing works. A factoring company typically pays you 70-90% of the receivables value upfront. The rest is paid at the maturity date of your receivables, after deducting the factor fee and other fees.
Learn more: Receivables Financing: The Ultimate Guide
Following is an example with actual numbers.
The 5% factor rate is essentially a discount paid for early cash flow. It means that in the end, you will only receive 95% of the $20,000, which is $19,000.
In a receivables factoring arrangement, the factoring company is responsible for debt collection.
To minimize the risks of customer default, the factoring company will only give you 85% of the receivables value as an upfront payment, which is $17,000 in this case.
You will collect the remainder, which is $2,000, at the maturity date of your receivables, after the factoring company successfully collects the sum from your customer.
A quick summary of this receivables factoring arrangement is included below:
Note: Receivables factoring could be recourse or non-recourse.
In a recourse factoring arrangement, you will have to buy back or replace any non-performing receivable. In a non-recourse factoring arrangement, you will not be responsible for non-paying customers’ debts.
Learn more about recourse vs. non-recourse factoring in our blog article on invoice factoring.
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What exactly is working capital financing? What are the methods of financing working capital? We have the answers for you.
This article guides you through the fundamentals of merchant cash advance, including how it works, pros and cons, and the costs of MCA.