Invoice factoring is also referred to as accounts receivable financing. Technically, it is a financing transaction where a business sells its invoices to a factoring company so that it can get instant cash to meet its immediate needs. Invoice factoring saves businesses the trouble of having to wait for clients to pay. The accounts receivable financing company provides the business with capital to enable it to handle daily business operations, pay its employees, and offset its pending bills. Moreover, invoice factoring is an effective way to grow your business without going through too much struggle.
Some pros of Invoice Factoring
- It provides immediate funding to businesses
- It involves an easy transaction
- It does not increase the debt
- It is assigned based on the clients’ credit status; not the business or business owner
- It cuts the time businesses have to wait for the client to pay
The cash that an accounts receivable financing company provides you is dependent on the payment history and the credit of your customers. It does not rely on your firm’s credit history or yours. Additionally, the immediate cash you receive from the factoring company is not given as a loan.
Steps Involved In Invoice Factoring
The invoice factoring process is not a complicated one. It involves a couple of transactions between a business and the factoring company. Here are the steps that are followed.
- A business finalizes its work and billing as usual
- The business sends its invoice(s) to the factoring company
- The factoring company deposits a cash advance within a day into the business’ bank account
- The customers pay the invoice to the invoice factoring company
- The factoring company pays the business the remaining balance, but they have to charge the business some fee
Comparing Accounts Receivable Financing To Loans
Majority of the businesses require financing so that they can continue running their operations smoothly. And the truth is, there are a lot of financing options available. One of the most common financing institutions that businesses go to when they need some cash is the bank. Businesses, however, must know that banks offer loans and they have more stringent lending terms compared to other financing institutions.
The process of obtaining a bank loan is long and complicated; when you apply for a loan in the bank, it could even take months before your loan is processed. Additionally, banks have to assess your line of credit, and if your business has zero or poor credit, you will not get the loan you wanted.
Invoice factoring, however, is a less complicated process. The factoring company can approve your immediate cash needs in even 15 minutes. The money is does not take more than 24 hours to get credited into your account. Moreover, the factoring company does not consider much before it provides you with financing. Unlike traditional lenders such as banks that look at your business or personal credit, a factoring company is only concerned with your clients’ credit. This makes it easier to obtain funding so that you can continue growing your business.
Which Agreements Are Involved In Invoice Factoring?
Accounts receivable financing is a financial transaction. As such, there has to be a binding agreement between the factoring company and the business looking to receive the funds. The agreements in this kind of transaction include:
The factoring volume
These transactions usually have a volume commitment. Here, the factoring company agrees to handle a particular number of invoices. It enables a business to have as much cash advances as it requires to handle its immediate cash needs at friendly rates.
The length of factoring agreements
The agreement that a factoring company has differs from one business to the other. Some contracts are written to last a couple of months while others can last for a couple of years.
Factoring companies usually charge businesses a specific fee for the service that they provide. The fee that is charged is based on the customer pay trends and the volume of a business’ invoice among other factors. There are factoring companies that charge a flat rate for the service offered although you will find factoring companies that charge an extra fee for the additional services provided. Therefore, before you sign a contract with a factoring company, make sure to check the terms of the agreement thoroughly.
Advances from accounts receivable financing companies
More often than not, factoring companies provide advances from 70 percent up to 90 percent of the invoice amount. The amount given is determined by the pay trends and clients’ credit status. If your firm’s clients have favorable credit, a factoring company is likely to clear more of your invoices.
Types of Accounts Receivable Financing Companies
I. Factoring Generalist – This is a factoring company that offers finance to a wide array of industries.
II. Factoring Specialist – This is a factoring company that gives financing to a specific industry
III. Recourse Factoring – Here, the factoring company reserves the right to sell your invoices back to you when your clients fail to make payments within the specified period.
IV. Non-recourse Factoring – Here, the factoring company takes the full risk of the invoices you sell it.