The Truth About Invoice Factoring: All You Need To Know

As a business owner, it’s possible to turn your unpaid invoices into cash fast with invoice factoring. It’s an excellent financing option for companies that experience longer times between product or service delivery and payment. When you have customers who typically don’t pay for goods or services straight away, it can result in cash flow issues.

 This is makes factoring an ideal financing alternative when you need urgent cash to meet business running costs that can’t wait including paying suppliers or employees. 

 

What’s Financing Using A Company’s Receivable Invoices 

Known as another financing method for entrepreneurs, invoice factoring is where you sell your unfulfilled invoices to a company that offers invoice factoring services and you receive cash in exchange. The amount only accounts to only a percentage that’s often 10% and below. The factoring company then collects payments from your customers as per your payment terms. 

When the company collects payments, they pay the remaining amount to you after deducting their fees.  It’s important to ask about the fees before you hire an invoice factoring company as it varies. 

Notably, factoring in your invoices doesn’t mean that your business is struggling financially or unable to serve your customers reliably. It’s not a loan, and you don’t have to worry about paying the money back. It serves its purpose best by helping businesses maintain cash flow despite the length of invoice wait times.

  

Types Of Invoice Factoring

There are two types of invoice factoring: 

  • Recourse factoring: This is the most popular among many factoring companies. It’s where you pay back the factoring company for the invoices they’re unable to collect from your customers.
  • Non-recourse factoring: Here, the factoring entity assumes responsibility to bear the risk of uncollected invoices. If the factoring company is unable to collect an invoice, they don’t return it or hold your business liable in any way. However, the fee charged in this type of factoring is said to be higher than in recourse factoring. 

How Does It Work

The factoring process has four components; your business, your customers/debtors, one or more pending invoices, and a factoring company. The factoring process follows the general steps below:

  1. You transact with a customer and issue an invoice with a due date, commonly between 30 and 90 days.
  2. You find a factor and set an account with them.
  3. You submit the outstanding invoices to the factoring company for funding. Some companies will require you to factor in all the invoices you receive during the contract. Others give you an option to factor in the ones you want. 
  4. The factoring company evaluates your application for funding and conducts due diligence to ensure that the invoices are authentic.
  5. If all goes well, the factoring company pays a cash advance based on the percentage agreed upon.
  6. When the invoice falls due, your customer pays the amount in the invoice directly to the factoring company. The process is completed when the factor deducts the advance payment and their fees and pays the balance to you.

 

Reasons To Consider Invoice Factoring

Invoice factoring has several benefits to business that makes it worth your consideration. Here are a few reasons:  

  • Access to cash fast: Factoring turns your invoices into cash fast, providing you with the working capital for technology upgrades and the like that you need to cover the gap resulting from slow-paying customers. Most factoring companies are mainly concerned about the creditworthiness of your customers.
  • Improved cash flow: Your business processes will continue to run as usual without having to put pressure on your customers to pay or you digging deep into your pockets to cover the same.
  • You don’t need collateral: Since factoring isn’t a loan, you need to offer security for the money you receive. You’re selling your business asset, which is your invoices. There’s no risk of losing your inventory, real estate, or business equipment to the factoring company.

 

Disadvantages Of Invoice Factoring 

Although there are beneficial reasons to choose invoice factoring, there are also drawbacks that you need to have in mind.  

  • You lose direct control of invoice collection and you may need to ensure that your customers are being dealt with fairly. Otherwise, it can lead to a strained relationship with your loyal clients.
  • There’s no guarantee that the factoring company will be successful in collecting payment. If your agreement is under the recourse factor, the company may require you to replace the invoice or pay back the amount advanced to you.
  • It’s relatively expensive when compared to the traditional lines of credit.

 

Takeaway

Factoring is a viable financing option for many businesses in various industries to help raise working capital. It provides a way for businesses to access funding quickly, making it an excellent choice for many businesses. 

However, you must evaluate your business needs against the factoring options available to ensure that it’ll make financial sense. Since every factoring company has its own terms and conditions, ensure you fully understand the points provided before signing an agreement. 

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