The process of invoice factoring consists of an organization using the services of a factoring company to take care of its open receivables. Doing so results in numerous benefits, including not needing to spend time and money waiting for customers to pay their invoices and receiving the vast majority of that money upfront from the factoring company. As a result, all of the expenses that go into the daily operations of the business can be much more easily taken care of.
It’s important to note that this is not a loan, so no debt is being created by using this type of service. Instead, what occurs is that the payment and the credit history of the customers of that business are considered when determining the amount of the cash that is received from this process. For these reasons, invoice factoring is especially enticing for companies that don’t want to create or increase their debt or might not qualify for traditional loans.
The Steps of Invoice Factoring
Anytime that an invoice is created and would otherwise be sent to the customer, it instead gets sent to the factoring company, which purchases it and handles the process of being paid by the customer. Once this occurs, it sends roughly 90 percent of the amount due to the company that is using the service. Most of the remaining balance is then paid once the customer takes care of the invoice on his or her end. A small fee remains with the factoring company.
Benefits Over Loans
Probably the most noticeable benefit of using invoice factoring is being able to receive the money in a much quicker time frame than would be possible when either waiting for the customers to pay the invoices off or attempting to get a loan or line of credit. As far as a loan or line of credit goes, it should also be noted that, even if you are approved for this, it will create debt while invoice factoring won’t. Also, companies that cannot be approved for those or are approved for relatively small amounts often urgently need the cash, usually even more urgently than those organizations that can be more easily approved for loans or lines of credit.
Meanwhile, those applying for invoice factoring are generally approved in minutes. Of course, the exact invoice factoring lines that are approved can vary a bit, but they generally range from $50,000-$20 million.
Invoice Factoring Agreements
Four aspects of the factoring agreements are the most important: length, volume, rate and fee.
The length of the contract can vary quite a bit, often for several months but even as long as a number of years. Some factoring companies also offer month-to-month contracts.
A volume commitment is included in most factoring agreements. The more volume of invoices that a company can guarantee, the more money and lower rates that it will receive as a result.
The exact percentage of the invoice amount that is provided right away varies on a number of factors such as volume, pay trends and how credit-worthy the customers are. They generally start at 70 percent.
The amount of the fees also depends on a number of factors. In this case, these include the volume and size of your invoices, the pay trends of the customers, the industry that your company is a part of and so on. Conversely, some factoring companies charge everybody the same fee.
Invoice Factoring Company Types
Some factoring companies provide their services only to organizations in a specific industry. For example, one such company might only work with trucking businesses. These are called factoring specialists. Conversely, the other main type of factoring companies, factoring generalists, provides services to all types of companies.
Another difference between factoring companies are those that are recourse and non-recourse. The former, which is most common, reserve the right to sell invoices back to the companies that it works for if the customers haven’t paid them in a certain time period, generally at least 90 days. Meanwhile, non-recourse factoring means that the factoring company is responsible for the invoices in the end, even if they’re not paid. Do note that these types of factoring companies are relatively rare.