Invoice factoring can be defined as a financial transaction where a particular business sells all its accounts receivable to a company in order to free up their cash reserves. This is done to secure working capital for meeting expenses, expand sales or to cover up payroll. Terms like “receivables financing”, “Invoice financing” or “accounts receivable financing” are used interchangeably while referring to Invoice Factoring.
How does it work?
After any company delivers their services or products to their designated customer, an invoice is issued by the company. The invoice is then sold off to the “factor” who gives an advance of about 70%-90% of the value of the invoice to the company. This received value is very helpful for maintaining the overheads of the company while waiting for to get more work/orders. After the outstanding invoice is paid by the debtor, the business gets a rebate for the remaining funds minus the fee based on the value of the invoice and its term. All parties benefit from the same.
Pros and Cons
Nothing is free of pros and cons and Invoice Factoring is no different in that respect.
- The application process is simple
- Higher rates of approval and faster funds mean that the company can focus on other important things and will grow rapidly
- Customer relationship may get damaged because many customers do not want their invoice to go for factoring
- Not all companies are able to make proper use of the funds generated and this may lead to furtherance of debt
A couple more points to keep in mind-
- Deciding on the best suitable factoring company- It is very important to find out the suitable factoring company as that would help the business in the long run as the business and the factoring companies essentially become inseparable.
- Deciding on rate of possible cash up-front or the percentage of advance on the invoice- A fair rate of advance is anything between 70% to 90% of the invoice value. The credit line depends entirely upon the business’s invoices and accounts receivable.
- Seeking transparency in factor rating and fees- Many invoicing companies advertise low rates of factoring but will include many hidden fees for invoice factoring. It is best to stay away from such companies as letting them factor the invoices could lead to losses.
- Not getting trapped into contracts by the factoring companies- This is another important law that locks the businesses into long-term bonds/contracts. It is best advised to study the market and be wary of such companies.