Invoice Factoring is a debtor finance that counts as a financial transaction. A business sells its accounts receivable (invoice) to a third-party factor – at a lower price.
Businesses factor their invoices as means to meet its immediate cash needs. The assets are also factored to respond to credit risk. There are a variety of asset-based lending using the resources of a company as collateral.
How to Qualify for Invoice Factoring
Invoice factoring is best an option for businesses that have an excellent credit history. You also need to have outstanding invoices that have not been paid. If it is just planned or proposed, it will not make the cut. It must be reasonably timed with a payment duration of three months or less.
The company must have a spotless financial and tax background for invoice factoring to work. There should be no complications when it comes to tax and bookkeeping. Apart from the business, the owner should have no outstanding legal issues.
Knowing the Methodology of Invoice Factoring
Step One: Create invoices for clients who have a solid history of paying on tije by providing goods and services to creditworthy customers.
Step Two: Unpaid invoices will be sold to an invoice factoring company.
Step Three: The company will verify the invoices, and when it has been completed, they will fund the business, using amounting to about 90% of the amount they receive – the rest goes to your company.
Step Four: Customers will pay directly to the factoring company by the terms of the invoice. The balance of the paid invoice will be returned to the company minus a fee.
Advantages of Invoice Factoring
- Quick Cash Flow. The release of money is more immediate compared to the traditional bank and credit funding. It accelerates the money flow by converting sales receivables into cash. This money can be used for sales increase, company growth, critical debt repayment, and capital investment.
- Reduced Collection. There are industries where accounts receivables don’t become liquid cash immediately. Invoice factoring can help in this regard so that companies don’t have blocked cash.
- No Collateral. Unlike banks that require collateral, invoice factoring can provide cash without any such requirements.
- No Impact on Business Relations. Since the invoicing factory is a third party, the typical relations between the seller and buyer won’t be hindered. The buyer will continue to be liable to the seller and no one else.
Disadvantages of Invoice Factoring
- Profit Margin Decrease. For their participation, invoice factoring companies will charge a fee that becomes an additional company cost. This will result in lower profits when interest and maintenance fees pile up.
- People Perception. Some clients may not see invoice factoring as a positive indication of the health of a company. Too much reliance on invoice factoring may not be regarded as positive by all stakeholders.
Assessing Invoice Factoring for Your Business
Invoice Factoring is a strategy that is not for all. New businesses will not see significant growth as it will affect their financial statements negatively. High-interest costs for a startup are not a healthy sign.
But it is a viable option for companies that have locked cash in between their account receivables and liquid cash. These industries include freight brokers, manufacturing, wholesale, IT, and technology, to name a few.
A Few Factoring Companies
If your startup or growing business is interested in learning more invoice factoring here are a few to checkout:
Interested in learning more about invoice factoring?
How to set your startup so it’s right for invoicing factor or more? Contact me today and let’s talk!