What is invoice factoring?
Invoice factoring is a means of availing funds to your business by selling invoices to a factoring company. A factor is a third party that provides cash to a business by purchasing accounts receivables such as impending payments. The factor gains by charging a discount or commission after paying you the value of an invoice.
The entrepreneur signs a contract that the factoring company will control the credit facility. Invoice factoring helps a business improve cash flow and enhance revenue stability when you have many clients owing you.
What are the requirements for invoice factoring?
The conditions for qualifying for invoice factoring differ from one factor o another. Typically, the factor can release funds within 24 hours after your clients honour your receivables.
The factor can charge a higher fee if they believe they’ll lose money if your clients cannot pay you. The factoring factor charges a relatively low fee when the risk is low.
Invoice factoring is an opportunity to transfer the risk of non-payment (default) from your business to a third party.
Benefits of invoice factoring
Your business gets instant cash injection which can help you fund your operations. It also improves working capital when clients owe you substantial amounts. Operating capital is significant in the success of a business because it represents the difference between revenue and other financial obligations.
Disposing a portion of your business accounts receivables protects your company from auctioneering by banks and other creditors.
Factoring is an expensive financing option but can significantly inject the needed cash flow. Factoring offers valuable service to businesses that operate in industries that take long to convert receivables into cash. It is also a prompt intervention for rapidly growing companies that want to leverage seasonal business opportunities.
Disadvantages of invoice factoring
- Extra charges unknown to the seller
- Factoring fee may be high, therefore inconveniencing the seller
- ● Long, complicated agreements
Who is involved in invoice factoring?
Factoring is a straightforward way of financing a business. The following parties are involved in a successful factoring agreement:
- Your business- the seller
- Your business client-the debtor
- The factoring company-the factor
4 steps of invoice factoring
1. The business or seller in need of funds submits their invoice to the factoring company.
2. The factor assesses the account receivables to determine the seller’s eligibility for funds.
3. The factor calculates the risk involved with the business client and advances the invoice value, less the commission. The factor deposits the amount in the seller’s account
4. The business client (the debtor) mails payment to the factor.
How invoice factoring can be used in a firm
Businesses use invoice factoring to:
- Increase inventory to improve margins
- Purchase new equipment
- Settle payroll on slower seasons
- Pay recurrent bills
- Sort staffing issues such as hiring
- Improve the business by marketing and advertising
Conclusion
Invoice factoring is a short-term financing procedure that allows a firm to sell unpaid invoices to a factoring company. It provides instant funds to ensure constant cash flow within a business.
