What is invoice factoring?
Although unknown by many, invoice factoring is something that has been practiced since ancient times. To put it simply, invoice factoring is the sale of unpaid receivables for cash. This helps companies that are growing or trying to meet cash flow needs by allowing them to immediately convert accounts receivable into cash rather than waiting 30, 60, or 90 days for their customers to pay.
How does invoice factoring work?
Step 1: Company completes the job and invoices its customer
Step 2: Company submits invoice to factoring company
Step 3: Factoring company verifies invoice
Step 4: Factoring company funds a portion of the invoice amount (typically up to 90%) while withholding the remainder as a reserve
Step 5: Factoring company monitors invoice and performs collections
Step 6: Company’s customer pays factoring company directly
Step 7: Company receives unfunded portion of invoice (the reserve) less factoring fee
What industries use factoring?
Invoice factoring is very common among small businesses in many different industries including oil and gas, staffing, manufacturing, and trucking. A common characteristic of industries that use invoice factoring is that they typically include small businesses that provide products or services to larger customers that have terms ranging from 10 to 90 days.
What are the benefits of invoice factoring?
Turn invoices into immediate cash
Factoring allows companies to utilize funds before their customers issue payment. There is no restriction on the use of these funds since the factoring transaction is structured as a sale of the invoice and not as a loan. Companies can use these funds for payroll, supplies, fuel, equipment, inventory, or any other purpose. Once the factoring relationship is set up, a good factor can provide same-day funding on each batch of invoices that are factored.
Avoid debt
Because factoring involves selling accounts receivable rather than lending, the company does not have any debt added to its balance sheet. This allows small companies the ability to avoid adding too much leverage and provides flexibility to the company should they experience financial difficulties.
Easier to access than traditional bank debt
A factoring company is less concerned with the credit of the company because the factor’s credit exposure is primarily to the company’s customer. This allows the company to avoid much of the red tape involved with a traditional loan.
Hire fewer employees
Another benefit of factoring is that after the invoice is purchased by the factoring company, the factoring company is responsible for monitoring and collecting on the invoice. This helps small businesses keep their headcount low by not needing to hire an employee to manage this process.
Flexibility on when you use factoring
Many factoring companies will allow companies to choose which invoices they factor. This allows the companies to decide to factor as needed. If a company does not have near term cash needs they can simply keep the receivables and wait for their customer to pay them in order to avoid paying a factoring fee.
Free credit checks on customers
Many factoring companies also provide free credit checks on customers. This allows a company to feel confident in a customer’s ability to pay before beginning a new business relationship.
What are the downsides of invoice factoring?
The rate for invoice factoring is often higher than traditional bank debt. Many companies that use invoice factoring do so because they cannot access traditional bank financing. Other companies qualify for traditional bank financing, but prefer the benefits of factoring including keeping debt off the balance sheet and keeping headcount low.