A guide to factoring receivable and why it is a good choice for your business Every business owner has a goal that they want to achieve. Among them is to see their business grow. But the problem comes when financial constraints strike due to delayed payments from customers, which becomes a major hindrance to not only pay for short-term financial expenses, you can also face challenges achieving long-term business goals. Customers delaying payments means that you may not be able to pay your employees on time, your rent will also […]
Every business owner has a goal that they want to achieve. Among them is to see their business grow. But the problem comes when financial constraints strike due to delayed payments from customers, which becomes a major hindrance to not only pay for short-term financial expenses, you can also face challenges achieving long-term business goals. Customers delaying payments means that you may not be able to pay your employees on time, your rent will also be delayed and this increases the pressure that comes with managing a business. The good news is that you don’t have to take out a long-term loan to provide working capital for your business. Rather than waiting for customers to pay, you can easily address the problem through invoice factoring.
The invoice factoring, also known as invoice financing or factoring industry has been around for decades. Some refer to it as accounts receivable financing or factoring receivable. This important financing option helps business owners meet their short-term financial needs.
Invoice factoring is a method of turning customer’s invoices into immediate cash. The factoring company which provides the cash is then paid by your customer. Here is a clear example of how invoice factoring works:
John, a store owner sells goods worth $100, 000 to client who promises to pay within 60 days. But since the payment will be delayed for more than a month, John does not have enough money to pay his employees at the end of the month. He therefore decides to approach a factoring receivable company. The company gives John the following terms:
John hands over the $100,000 invoice to the financing company. The company will then process the invoice and deposit the advance rate of $85,000 to John’s account. When the customer pays the $100,000 after 60 days, the factoring company forwards the outstanding invoices amount less the 8% fee.
In this case, John will be able to pay his employees on time, thanks to invoice factoring. There are also other situations where invoice factoring can benefit a business. They include:
The main difference between factoring financing and a business loan lies of the ownership of the invoice. If you seek the services of a factoring company, your invoices will be purchased at a discounted rate. But with banks, you have to issue the invoices as collateral for the loan. One advantage with invoice factoring is that your debt-to-equity ratio will not be affected, which will obviously happen if you talk about a traditional bank loan.
If the customer does not make payment as agreed, the factoring client is responsible for the invoice payment. This is called recourse factoring. You can avoid this by only factoring invoices from customers with good credit history. With non-recourse factoring, the invoices are sold to the factoring company which takes up all the risks for collecting the invoices.
There are 2 main factors that determine the cost of factoring
For instance, if your factoring company rate is 1% per week and your customer promises to pay in 4 weeks time, the factoring rate will be 4% of the invoice value. In most cases, the advance payment is usually 80-90% of the invoice value. The remaining amount less the factoring fee is paid once the customer has cleared the invoice. Some factoring companies also charge other additional fees which can also increase both factoring cost. The important thing is to work with a transparent company that is willing to inform you about these fees before taking the services provided.
Currently, there are many receivables factoring companies that factor invoices. This makes factoring rates competitive for the benefit of the client. But still, not all factoring companies provide quality customer service. When looking for a factor to provide cash advance, look for a company that has been in the industry for several years. They should also be in a position to offer flexible funding options.
This depends on your business needs. There are cases where businesses factor all their invoices while some only factors invoices that customers take long to pay.
Invoice factoring can be the ultimate solution for businesses that need immediate or short-term funding. To find the best factoring company, you should first understand your business needs and ask the necessary questions. This is the only way you can achieve your business financial goals and avoid any hidden charges.