What is Invoice Factoring and How Does it Work?

Money on a tree

Invoice factoring is a business finance tool that gives organizations immediate access to the money that is owed to their business by their customers, without having to wait for 30, 60, 90 days or even longer, for the invoices to be paid.

Invoice factoring and invoice discounting are the two types of invoice finance. The main difference between them lies in who takes responsibility for collecting payment and control of the sales ledger:

1. With invoice factoring, the factoring company takes the role of managing the credit control, sales ledger, and chasing the customers for settlement of the invoices. While with invoice discounting, the business of the organization chases payments in the normal way and retains control of the organization’s sales ledger.

2. With invoice factoring, the customers settles their invoices directly with the factoring company; as a result they are likely to be aware of the organization’s or company’s factoring arrangement. While with invoice discounting, the customers still pay the organization directly; the customers do not need to know that a third party is involved.

Within invoice factoring there are two further options, these are with recourse and without recourse. Recourse is when the customers of the organization default on their payment and the organization becomes liable for the balance that is outstanding (this is the money the organization has borrowed from the factoring company). Nearly all invoice factoring companies insure their clients against this eventuality for an additional fee.

Invoice factoring enables expedited flow of cash, this means more options and flexibility for organizations when it comes to them reinvesting the working capital in their business and meeting their operational expenses.

How Invoice Factoring Works
1. A company provides services or products to a customer (this may be another company or organization) and the company then creates an invoice.
2. Instead of the company having to wait for several weeks or even months for their customer to pay, the company sells (or factors) the invoice to a factoring company and they can then immediately have access to their working capital.
3. The factoring company purchases (or factors) the invoice, and they then advance around 80% to 95% of the face value at a discount (or minimal fee), usually around 1% to 5% of the total of the invoice; the remaining balance is then held in reserve.
4. Once the customer remits the payment for the invoice to the factoring company, the reserve is released back to the company that provided the services or products to the customer.

 

Benefits of Invoice Factoring
It enables companies leverage their receivables in order for them to grow their business by factoring their invoices — turning the cash their customers owe them into money that is immediately available. Instead of companies waiting for several weeks (or sometimes even months) for invoices to be paid, they can receive money for factored accounts receivable invoices immediately,
this enables them to:
1. Have a competitive advantage by offering credit terms that are more appealing to their customers.
2. Replenish the flow of cash more quickly, this makes the management of their day to day expenses a lot easier.
3. Leverage their purchasing power to negotiate better terms with their vendors and suppliers.
4. Pursue bigger and new business opportunities and clients as a result of expedite flow of cash.
5. Reduce the resources and time that are needed for collection and accounting activities.
6. Reduce or may even eliminate the financial risk that may occur as a result of a bad debt by working with a non-recourse factor.

3 Reasons Invoice Financing is better than a Bank Loan

Loan vs Invoice Factoring

Tough financial policies imposed by banks mean that getting bank loans is increasingly becoming difficult. Not only will you be required to follow a highly procedural method but you will also have to prove your eligibility to get a bank loan. Such conditions mean that bank loans cannot be reliable for urgent financing that businesses may face in the course of their daily operations. It is no wonder that invoice financing among other alternatives are increasingly becoming common among small business owners. This article aims to clarify on what invoice financing is and discuss the three main benefits that make it attractive to most borrowers.

What is invoice financing?

Invoice financing simply involves borrowing funds against the value of unpaid business invoices. For this reason it is also known as invoice discounting.The business owner gives the unpaid invoice to the invoice financing company in exchange of funds equating to its value. You are then required by the invoice financing company to follow up the invoices’ payment and settle the debt with the company when the invoice payment is made.

Why is the invoice financing option better than a bank loan option?

Invoice financing is flexible

Unlike normal bank loans, invoice financing options are not limited by the strict regulations that limit people’s chances to getting a loan. With invoice financing, companies bending their operational policies to ensure that they meet the specific needs of their customers. The basic principle is that the amount of loan borrowed and the payment duration is totally determined by your invoice. This means that the borrower does not have to involve in any pressurized repayment process. The loan is simply repaid as soon as the invoice is paid. This sort of tailor-made option with invoice financing loans allows business owners to borrow within their limit. The loan, therefore, offers you an opportunity to grow together with your business.

Invoice financing is cost effective

Compared to bank loans, invoice financing option is a very cheap method to borrow money. You stand a chance of getting up to 95% of the face value of the invoice issued. This implies that you only have to be charged 5% for what you borrow. Bank loans have higher interest rates which spread over a lengthy period. In addition to the lower interest rates, invoice financing allows the borrower to get the money within 24 hours after filling an application. Bank loans are not attainable within a day of application. Such high level of cost effectiveness means that invoice financing options offer borrowers a more reliable and cheaper option for urgent money.

Invoice financing does not require any security

With invoice financing options, you only have to present the invoice financing company with your invoice and prove its credibility by offering the supportive documents. On the other hand, it is impossible to go to a bank loan and request for a loan without offering a security. The issue of security curtails most people from accessing loans because unless you have a deed for a house or a log book, you cannot get a loan regardless of your ability to pay it back. Invoice financing options eliminate this hindrance to their borrowers.

For more information on Invoice Financing we suggest you visit www.invoicefunders.co.nz/what_is_invoice_finance