Invoice factoring refers to a form of invoice finance that involves selling part or all the unpaid company’s invoices to another company to boost cash flow and enhance revenue stability. Invoice factoring is also termed debt factoring or accounts receivable factoring. What happens is that a factoring company clears the invoiced amount instantly, after which they pursue your customers to collect payments from them directly.
Invoice factoring has multiple benefits, which we will discuss in this article. We will also highlight some of the limitations. Keep reading to learn.
Explaining How Factoring Works
As pointed out, invoice factoring is transferring/selling your control of accounts receivable in whole or in part to a different company. This is how it works;
- a) As usual, you’ll provide your customers with goods and services
- b) You send an invoice to your clients for the same goods and services
- c) You bring a factoring company on board by selling the raised invoices. The factoring company will pay for up to 80-90% for the raised invoices right away, but of course, after all the invoices are verified.
- d) The factoring company will be the one following your customers to pay the invoices
- e) Once the customers have paid, the factoring company will clear the remaining amount and deduct their service fee after they are fully paid.
Some Invoice Factoring Terms Explained
Accounts receivable- This means the money your customers owe your business. This money is normally paid after the delivery of goods and services.
Accounts receivable factoring- this is a synonym for invoice factoring. It’s a subcategory of invoice factoring that involves selling whole or part of your unpaid business invoices to a factoring company.
Approval period- The time set for invoices to be cleared. Bad debts can be a recourse to your company.
Cash flow- the amount of money a business receives within a particular period.
CHOCC (Client Handles Own Credit Control) factoring- invoice factoring involves following factored invoices instead of leaving the factoring company to do the job.
Confidential Factoring – factoring your invoices without disclosing that to your customers to protect your relationship
When Should you Consider Invoice Factoring
Although invoice factoring has its flaws, it can be of great help, especially if most of your company’s invoices are unpaid, thereby sabotaging your cash flow.
For instance, if your company sells on 60-day payment terms, most of your customers could pay within 60 days, but a section of them may need to be pushed. Still, you may have to apply more effort to get some to keep their part of the deal. Although not all who’ll give you a hard time, all this may be a big blow to your company’s cash flow. Invoice factoring can spare you the stress. It ensures that you get cash instantly after sending the invoices to keep things running in your company. Since you get a large part of the invoices, your cash flow won’t be affected. Therefore, you can use the money to do the following;
- Clear an outstanding loan
- Cater for urgent/ short-term expenses
- Have funds to seize seasonal business opportunities and so on.
Invoice Factoring Benefits
Below are reasons why invoice factoring matters;
Guarantees uninterrupted cash flow- When using invoice factoring, you’ll have the highest percentage of your company’s invoice cleared. So, you won’t have to wait for days or months for the money to keep your business running. That will make your business planning efforts more accurate. You’ll even be flexible enough to expand your business.
Enables your business to remain afloat- During tough economic times, getting customers to pay after receiving goods and services is a tough task. The invoice factoring company will shoulder the stress and provide you with instant funds, thereby keeping your business afloat. However, without invoice factoring, your business will have to brave poor cash flow, not to mention that it may even collapse if things get out of hand.
It’s the easiest way of accessing instant funds- As always, the process of getting a bank loan is not devoid of challenges. At times it may take longer than expected. But invoice factoring is an easy way of accessing cash. Furthermore, invoice factoring offloads you the burden of debt management, saving you time and money, especially if you have a large customer base.
Reduce your company’s overheads; invoice factoring can reduce your company’s overheads. Although you’ll have to cater for invoice factoring fees, that’s nothing to compare with the amount needed to pay credit control staff. Besides, invoice factoring boosts the morale of your account department staff since pestering customers to pay is an overwhelming task.
Invoice factoring shortcomings
Not suitable for businesses with a small customer base- invoice factoring works great with big companies, unlike small companies with few clients. That’s because factoring companies prefer to concentrate on companies with a wider customer base.
Requires a lot of commitment- While you can factor a part of your invoices commonly referred to as spot factoring or selective factoring, most factoring companies insist on controlling all your company’s accounts receivable. In addition, they can compel you to enter into a long-term contract such as two years or more which is a significant decision on your part.
May cost you more depending on your customers’ risk rate- Factoring companies do not commit to shouldering your companies invoices burden blindly. Their charges depend on their perception of your customer’s ability to pay. In other words, they consider a company’s credit risk after evaluating the type of customers involved. So, if your customers are considered high risk, you may be charged more.
You may have to refund the money paid- In cases where your customers refuse to pay their invoice even after frequent follow-ups, some factoring companies may require you to refund the money already paid except if you signed for non-recourse factoring- this is a case where the business owners do not cater bad debts. But this kind of factoring costs more than in recourse factoring.
You may lose your relationship with your customers- To some extent, you’ll have lost control over your customers by bringing a third party in. Keep in mind that a factoring company sometimes uses aggression when pursuing customers to pay money. In the process, your relationship with your customers may suffer a huge blow. If that happens, your business progress will be at stake.
Finally, invoice factoring is transferring the task of following up invoices to a factoring company. You get paid for the invoices immediately. While invoice factoring has its shortcomings, it’s worth it because it ensures you have good cash flow, remains afloat during hard times, and saves you the burden of debt management.