This blog post is significantly our most popular searched for entry. Originally done in 2011, here it is again.
Because accounts receivable factoring is a working capital form of commercial financing, there are important considerations concerning how you set up your business model. The payment terms and arrangements you have with customers is more important than one might think. Just a slight change in the way you bill for your services could make or break the ability to secure financing on the accounts receivables.
Whenever a business offers payment terms to their customers – they become a sort of a lender. The customer owes for the work, and the business is waiting for payment, essentially a business loan. There are things a business should note when offering terms that may bring beneficial results when looking to factor their invoices. If a company has a strategic financial plan with the intent to secure invoice factoring, then knowing what makes the transaction attractive may make a significant difference.
In the contract with your customer there will be conditions for payment which might include one of the following terms; milestone payments as opposed to progress payments. For a factoring company, these distinctions are critical to securing your financing.
Milestone payments in a contract are specific deliverables outlined in the agreement whereby when the milestone has been finished, the customer will pay an agreed amount. By specifying very tangible work events, the factor can verify with the customer they received a product or service outlined in a contract. In this case the factoring company will feel satisfied to make an advance on the future payment. By you knowing this distinction ahead of time and negotiating the necessary changes to the contract it will better guarantee access to outside capital further on down the line.
Progress payments, on the other hand, only allow for regular percentage payments of the entire contract. For example, on a large contract over a lengthy period the customer agrees to pay the business a monthly set amount. The difficulty with this arrangement is – for whatever reason if the customer is dissatisfied with the work they will stop making payments. This puts the factor in jeopardy trying to recover any capital advances. Many banks and finance companies will not make a loan on a progress billing contract.
A factoring company must be able to independently, if needed, go after the account debtor (customer) for payment of the invoice. This means that the work has to be completed and acceptable to the customer. Then the customer has no legal reason not to pay the invoice in full, and could be asked to defend non-payment in court. With a progress payment there is too much grey area and maneuvering room that could allow the customer to walk away from their obligation. A clean definition is preferable for work to be considered for invoice factoring.