Slow-paying clients can stall your entire business operation. Thus, plans like bills, technology investments or equipment, payrolls or even when you need to hire more staff to help scale up operations, all these can be thwarted. Nevertheless, there’s a solution which is invoice factoring.
It can be quite expensive to go for a traditional bank loan, coupled with the fact that you get to incur immediate debt when obtaining one.
When clients take more than 180 days to pay for a job you have done for them, what do you do in such situations?
This is where the invoice factoring solution comes in, where a business can get immediate cash advances on every outstanding invoice. Learn more in the following paragraphs.
The Basics of Invoice Factoring
Factoring your invoice means selling ownership of your accounts receivable, either in part or in full. It operates like this: you offer products or services to your clients in the usual manner. The factoring firm shall pay you the remaining invoice sum, minus their commission until they have been paid in full. The invoice factory procedure is quite simple: you sell your outstanding invoices to a third party (a factoring firm that pays a lump sum, this is typically between 70 – 90 per cent of the total invoice). The money sent can be forwarded straight to your business account to be immediately used as working capital.
This is so beneficial to businesses becue rather than having to wait for as long as 30 to180 days for client’s payment to your business, you can receive this money in a matter of days from an invoice factoring firm.
Another thing to note is that the factoring company will charge a factoring fee for the service rendered. This is typically a percentage of the invoice amount. The responsibility of getting the outstay ding invoice will be shifted to the factoring company (terms and conditions apply, be sure to check).
While it can be advantageous for small business owners to partner with an invoice factoring firm, some drawbacks come with it. Before applying for invoice factoring, you can consider the pros and cons, so keep reading to see if this is the right choice for your company!
Examples of Invoice Factoring
Here’s a super simple example.
You’ve just sent your client Starks industries an invoice for $200,000, payable in 60 days. The problem is, you need cash ASAP to buy new production equipment. So you factor the Stark’s industries invoice. The factoring company gives you $200,000, minus a few per cent to cover their rates.
Difference between Invoice Factoring and a Loan
In dealing with invoice factoring, it is important to understand that, it is very different from borrowing in an organisation’s sell accounts receivables rather than merely serving as collateral. The immediate result is that your organisation can immediately convert the receivables into instant operating cash. This saves the time of having to wait for over 60 days or more for clients to pay.
Non-recourse factoring offers organisations some added advantages to protect them against insolvency or bankruptcy. Fact is that it is only the professional invoice factoring organisations that will offer you a non-recourse factoring service. This is very important, especially in today’s volatile economic environment. Sometimes, you can expect the unexpected as businesses are expected to protect their interest and livelihood.
The factoring process shifts the time, expense and commitment of the compilation in the factoring business’s hands. Invoice Factoring provides a business with ample time to focus on what you do best – manage the company. Your company will obtain the cash it wants where it needs it so that you can better handle your business.
Invoice factoring is an ideal choice for businesses that need funds fast but cannot obtain a traditional loan from banks. A lot of people relate to IF (Invoice factoring) by various terms, such as debtor funding, receivables factoring invoice factoring, and invoice discounting.
Good factoring firms can review the credit history of the seller’s buyers before buying invoices. Factors would like to be sure that these businesses have a tradition of covering their bills. The factor would also allow for non-recourse factoring. Non-recourse covers the business if your firm is insolvent during the transaction time.
How Expensive Is Invoice Factoring?
A factoring firm would bill 2 per cent for the first 30 days and 0.5 per cent for every ten days the invoice remains outstanding. Fees are also alluded to as invoice discount rates. Most factoring firms offer a flat rate arrangement where a one-time fee is paid in advance.
- A business gets to have an organised cash flow: The use of invoice factoring, most of the invoices will be charged nearly directly, instead of waiting for the payment to come in.
- You have a greater chance to survive in business: Better cash management gives the company a better chance of succeeding. Many companies struggle due to inadequate cash flow, and invoice factoring will keep you safe – as long as you use it wisely.
- Unarguably cheaper than the traditional bank loan: Invoice factoring is generally more affordable than a bank loan and easier to receive, making it good for short-term lending purposes. It even puts the debt management issue out of your hands.
- Invoice factoring sometimes requires a major commitment from your business: While a limited number of invoices (known as partial factoring or spot factoring) will often be factored in, most factoring firms may choose to take up the majority of their accounts receivable.
- Invoice factoring may not suit businesses with a small amount of customers: This model is not ideal for businesses with just a couple of large clients. Factoring firms tend to distribute their risks as thinly as possible. They are attempting to stop a heavy accumulation of invoices for only a few clients.
- Might cost extra if t doesn’t work well: There could be extra disbursements to be charged if the clients become poorer payers than expected. If the client fails to pay, you will have to refund the factoring company has already charged to you, and you pay more for non-recourse factoring.
Pros of Invoice Factoring
- You get immediate instant cash flow as a business.
- There is an ongoing cash flow.
- The chances of getting approved for invoice factoring is high.
- There is no involvement of collateral.
- Improved customer relationship
- Ability to outsource
Cons of Invoice Factoring
- You might be responsible for unpaid invoices.
- Sometimes it can be expensive to start.
- Lack of control
- Somewhat too much dependency on customers