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 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.
What is factoring?
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:
- Advance rate 85%
- Fees 8% per 60 days
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:
- When you need funds for business growth
Every business owner knows that they need to spend money to make money. Invoice factoring provides funds to purchase supplies, pay your creditors, advisement expenses, among others.
- When you need instant funding
Invoice factoring companies can approve funds is as soon as 1 business day. If you are faced with issues that require immediate funding, factoring receivable can help fill the gap.
- If qualifying for a bank loan is almost impossible
The good thing with factoring companies is that they don’t consider bad credit scores and bank account balances to qualify businesses for funding. What matters most is the value of your invoice.
- When you want to focus on your business
As a small business owner, time means money and you should therefore create time for your most valuable resource-the business. Rather than worrying about when payments will come in, you can put more focus on the growth of your business.
Factoring vs. traditional bank loans
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.
Recourse and non- recourse factoring
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
- The discount rate
- The time between the advance payment and when the invoice will be paid by your customer
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.
What companies provide factoring?
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.
How much do you need to factor?
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.
What are the benefits of factoring?
- Saves time and hassle
Bank loans require a lot of paperwork which can take weeks for the loan to be processed. With accounts receivable factoring, you can get a decision in a few days and there is also less paperwork involved.
Invoice factoring companies transfer the funds to your bank account within 24 hours.
- No credit check
Compared to most financing options, you can still qualify for fast business loans if your business has poor credit. Your customers’ credit is what matters more than your business history.
- No debt
Factoring is an advance payment of the money that you already have. This means that you won’t have to worry about future debts.
- Boosts your credit score
If customers pay their invoices on time, the factoring company will send a report to a credit agency and this will increase your credit score.
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.
Joshua is a financial lawyer who plans on writing a book about his experience on debt collection laws and lending terms and conditions. He is currently one of the senior partners at his law firm but wants to take more time off for his writing.