You may be thinking, “What is invoice factoring and how can it benefit my business?” You simply sell your accounts receivable (invoices), less a small discount, to an invoice factoring company. After verifying the creditworthiness of your invoiced customer, factoring companies advance up to 100% of the invoice, providing you with immediate cash flow that you can use for your business needs.
In a recourse factoring agreement, you would likely see 100% progress, whereas a trucking company with a non-recourse factoring agreement would likely see 90% to 97% progress, and an enterprise factoring agreement would likely see an advance of up to 95%.
And when your customer pays the invoice, the factor remits the balance, minus a commission, to your company.
So instead of waiting 30 to 120 days – or even longer – to receive payment from your customer, get your invoice financed in 24 or 48 hours.
To learn more about how invoice factoring works, do not hesitate to contact us: we will be happy to answer all your comments, questions, and concerns. We look forward to hearing from you.
Invoice factoring is a financial transaction and a type of debtor financing. In an invoice factoring agreement, a business sells its accounts receivable (invoice) to a third party (called a factor) at a discount. A business typically factors its receivables to meet its current and immediate cash needs, rather than waiting for payment under the terms of the original contract. Invoice factoring is also used to mitigate credit risk.
It can also refer to factoring as accounts receivable factoring, invoice factoring, and sometimes mistakenly, accounts receivable financing. Accounts receivable financing is a form of asset-based lending (ABL) that uses a company’s accounts receivable as collateral.
How does invoice factoring work?
Step 1: Your B2B or B2G company provides goods or services to more creditworthy customers and submits correct invoices.
Step 2: Your company needs to collect before the agreed deadlines (that is, 30-90 days) with your clients.
Step 3: Your business sells your unpaid invoices to an invoice factoring company under a factoring agreement.
Step 4: The factoring company verifies that the invoices are valid and the B2B or B2g company receives up to 90% of the invoice amount. Once the account is established, payment can be as fast as 24 hours.
Step 5: The most creditworthy clients pay directly to the factoring company according to the conditions of the invoice. The factoring company then returns the balance of the invoice to the B2B or B2G company less than a commission.
How is invoice factoring different from a bank loan?
When understanding invoice factoring, it is essential to remember that factoring differs from loans in that companies sell accounts receivable rather than simply serving as collateral. The net result is that your business can convert its accounts receivable into immediate operating cash. This way, you won’t have to wait 30, 60, 90 days, or more for your customers to pay.
Non-recourse factoring offers the added benefit of protection against insolvency or bankruptcy. Only the best and most experienced factoring companies are able to offer non-recourse to their clients. This is especially important in today’s uncertain economic environment. Expect the unexpected, as entrepreneurs must be diligent in protecting their own interests and livelihoods.
The factoring process puts the time, cost, and effort of the collection in the hands of the factoring company. Factoring allows you time to focus on what you do best: running your business. Your business receives the cash it needs when it needs it, so you can better manage your business.
Invoice factoring can be an excellent option for companies that need money quickly but cannot obtain a conventional bank loan. Many refer to business factoring by various names, such as accounts receivable factoring, invoice discounting, invoice factoring, and debtor financing.
Good factoring companies will research the credit history of the seller’s clients before purchasing the invoices. Factors will want to be sure that these companies have a history of paying their bills. The factor will also provide non-recourse factoring. The absence of recourse protects your company in the event that your client becomes insolvent during the transaction period.
Fully understanding invoice factoring is a great way for companies to inject cash into their business without taking on additional debt. By selling their receivables at a discount, they can get money without waiting to collect it themselves. Accounts receivable financing is a great financing option for most industries such as trucks, personnel, distributors, and importers.
When Should Your Business Use Factoring?
Your business should use invoice factoring when you routinely have a lot of outstanding invoices and your cash flow is affected by it.
For example, let’s say your business sells with payment terms of 30 days. Most of your debtors will pay within 30 days – some may require prosecution, some may not – while others may exceed the limit and require more persistent effort on your part. That 30-day chunk of income may make up most of your potential cash flow, but you can’t really use it. Invoice factoring allows you to release that money almost immediately, or at least a large part of it. You can use that money to
- Cover short-term expenses
- Pay off a loan
- Take advantage of seasonal business opportunities
- Or for whatever reason, cash flow could be a hindrance.
Advantages of factoring
Improved and more predictable cash flow – By using invoice factoring, you can have most of your invoices paid almost immediately rather than having to wait for the money to arrive (possibly after a long chase on your part). It makes your business planning and forecasting more accurate and enables you to seize opportunities that would otherwise be unaffordable.
More Chances for Your Business to Survive – Better cash flow gives your business a better chance of survival. Many businesses fail due to a lack of liquidity, and invoice factoring can keep yours in good shape, as long as you use it wisely.
Cheaper and easier than a bank loan – Invoice factoring is usually cheaper than a bank loan and easier to obtain, making it good for short-term financing needs. Plus, it frees you from the hassles of debt management. Depending on the size of your customer base, this can be a huge saving.
Reduce Your Business Overhead: Invoice factoring services can reduce your business overhead. Although invoice factoring has associated expenses, these may be less than the cost of paying personnel dedicated to credit control. Invoice factoring can also improve the morale of the people who work in your accounting department, as chasing down payments is often a stressful job.
Disadvantages of factoring
Not suitable for companies with few clients: Invoice factoring is not suitable for companies with only a handful of main clients. Factoring companies prefer to spread their risk as widely as possible. They try to avoid a high concentration of invoices in a few clients.
It takes a lot of commitment: Although it is sometimes possible to factor in a small number of invoices (known as selective factoring or point factoring), most factoring companies will want to take care of the bulk of your accounts receivable. They may also try to tie you to a long contract, which can be two years or more. This is necessary from their point of view, but it means that you can’t go in and out of invoice factoring at any time. It is an important business decision.
It costs more if your customers are risky: Factoring companies do their best to accurately determine the risk of bad debt or non-payment. This means that they will carefully evaluate their clients. Your rates will reflect your perception of credit risk: If you or your customers are considered high risk, the rates will be high.
Additional costs when it doesn’t work – There may be additional outlays to pay if your customers turn out to be worse payers than expected. If a customer does not pay, they may have to pay back the amount that the factoring company has already paid them, unless they pay extra for non-recourse factoring. In short, don’t expect a factoring company to take over your bad debts for nothing. They are in business to make money, just like you.
It can hurt your customer relationships – When you factor invoices and credit control is taken by the factoring company, you are also giving up some control of your customer relationships. If the factoring company pursues debt coldly or aggressively, you run the risk that your clients will stop working with you in the future. They may also see the involvement of a factoring company as a sign that their business is not doing well.