Selling Your Receivables - The Pros and Cons
So you’re considering selling your invoices/receivables. You’ve heard about it, maybe even known someone who’s doing it. But you’re not sure if it’s for you. How do you go about making that decision?
Your first step is to define your reasons for wanting to sell your receivables.
Frequently the major reason is immediate cash flow. If you carry your own receivables, you need deep pockets to keep your business afloat until your customers pay their bills. While you wait for your customers’ payments, your cash is tied up, unavailable for your inventory, payroll, utilities, and other expenses.
Or your business may be growing. In that case, you probably need more inventory and/or working capital than your current budget will handle.
Is handling your own receivables taking too much of your time and office resources? Some receivables purchasers will take care of your entire A/R procedures. You simply create the invoices and send them to your receivables handler. Your receivables purchaser sends out your monthly statements, receives payments, follows up with collections on slow pays, and may even create payment plans to fit your customers’ needs.
There are many reasons for considering selling your receivables. But before you start looking for a receivables purchaser, be sure you know exactly what your reasons are. Make a comprehensive list of all the benefits you hope to gain.
If all you want is an ease in your cash flow, almost any receivables purchaser will do. However, since the growth spurt in this industry, purchasers are all over the map in what they offer and how they function.
Will you continue sending your monthly statements? Or will the purchaser? Who will handle the slow pays? Will you be responsible should your customer default on his payments, or is this an expense your purchaser will assume with its corresponding increase in discount? Are you going to check out your customer’s creditworthiness, or will your factor vet them for you?
These are all questions that will help you decide exactly what you want in a receivables purchaser.
On the other hand, there may be disadvantages to selling your receivables.
Your cash for your receivables shrinks with the discount you yield to the purchaser. To offset this discount, you may need to consider restructuring your prices.
You cannot use your receivables as collateral for traditional bank loans. If you already have an operating loan which includes your receivables as collateral, you will need to renegotiate with your bank.
If you find a full service purchaser, you may get caught up in the freedoms it has allowed you and not pay as close attention as you once did to how well your customers are fulfilling their obligations.
When you sell your receivables, you essentially add another department to your business. There is always the transitional time which adds stress as you feel your way into this new relationship. And sometimes there is a feeling of loss of control.
The biggest factor may be the wide openness of the receivables purchasing field. You have everything from traditional factors to purchasers who deviate substantially from the original model. That’s not necessarily bad, just different.
Making the choice of a purchaser needs to be part of the decision whether to sell your receivables or not. And you need to shop around until you find a good fit.
If you choose a traditional factor, you will receive a percentage of the invoice sold - say 70% or 80% - at the time of purchase. When your customer pays the factor, you will receive the other 20% or 30% less the factor’s discount. That discount may be as little as 5% or as much as 10% or more. But the purchaser assumes the loss if your customer defaults. In which case, you have received the predetermined percentage of the invoice instead of bearing the whole loss.
On the other hand, there are purchasers who will take the invoice and return 95% to 98% of it to you immediately. Generally these are full recourse purchasers. So if your customer defaults, you will assume that loss. However, you can minimize your risk by extending credit judiciously. Some purchasers maintain a credit bureau account for this very purpose and will pull reports upon request.
Disclaimer: The percentages above were pulled as round number examples. They are not to be relied upon as actual for any receivables purchaser. You will need to discuss discount specifics with any prospective purchaser.
Another consideration needs to be the back office services your purchaser offers. Will they send your statements? Do they attach invoices? Will they follow up on slow pays? How far will they go in collections? Again there is a wide spread between purchasers. The choice is yours.
A foundational consideration in choosing a receivables purchaser lies in the lines of communication. Who is responsible for what in the exchange of information?
For example, if your purchaser sends your statements and you learn of a customer’s address change, how do you communicate this? Is there a form? Can you just change the address on the next invoice for the purchaser to pick up? Do you make a phone call to the account rep?
How often will you get reports on customer payments? And which reports will you get?
This is just a sampling of questions you will need to answer when considering selling your receivables.
Much of your decision depends upon how accurately you can forecast your needs and envision possible scenarios. A successful relationship with a factor or receivables purchaser rests on the foundation of how well you have anticipated possible contingencies.
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