Invoice Factoring is a financial transaction whereby a business sells its accounts receivables, also known as invoices, at a discount. Factoring differs from a bank loan in three major ways. First, the emphasis is on the value of the receivables, not the customer's credit worthiness. Second, factoring is not a loan, it is the purchase of an asset (the receivable). Third and finally, a bank loan typically involves two parties whereas factoring involves three. Companies which offer factoring services will provide you with a factoring quote as to what your accounts receivables are worth.
A company sells its invoices, even at a discount to their face value, when it calculates that it will be better off taking less of a profit than it would be by attempting to function as its customer's "bank." In other words, it figures that the return on the proceeds will exceed the income on the receivables.
The three parties directly involved are: the seller, debtor, and the factor. The seller is owed money the debtor. The seller then sells one or more of its invoices at a discount to the third party, the specialized financial organization, the factor, to obtain cash. The factor will give the seller a factoring quote as to what the receivable is worth. The debtor then directly pays the factor the full value of the invoice. Factors make funds available by focusing first on the credit worthiness of the debtor, the party who is obligated to pay the invoices for goods or services delivered by the seller.
In contrast, the emphasis in a bank lending relationship is on the creditworthiness of the small firm, not that of its customers. While bank lending offers funds to small companies at a lower cost than factoring, the terms and conditions under which the small firm must operate differ greatly. Bank relationships provide a more limited availability of funds and none of the bundle of services that factors offer.
From a cost and availability of funds perspective, Invoice Factoring creates wealth for some but not all growing small businesses. For these businesses, their choice is slowing their growth or the use of external funds beyond the banks. In choosing to use external funds beyond the banks the rapidly growing firm's choice is between seeking angel investors for equity or the lower cost of selling invoices to finance their growth. The latter is easier to access and can be obtained in a couple of weeks compared to the six months or more that securing funds from angel investment typically takes.
Invoice Factoring - Acquiring The Financing You Need To Run The Business
Looking for small business financing has always been a challenge for company owners. Even in good times, qualifying for the financing you need has been difficult. As a rule, most banks require that your company has a track record of success and they need a few years worth of financial history. Most importantly, institutions want to make sure you have collateral - things like equipment and real estate - to back your business loan. Because of this, many industries with no hard assets such as staffing and consulting have a hard time obtaining business loans.
There are others form of financing that can help business owners - at least in some specific situations. One form of financing that has been gaining traction in the past few years is invoice factoring. It can be an ideal solution for companies that are waiting 30 to 60 days to get their invoices paid, but need the money sooner.
For example, let's say that a construction company invoices $150,000 to a client that will be paid in forty-five days. In the meantime, the construction company needs to pay employee salaries every two weeks. If the company does not have enough funds to pay employees while waiting to get paid, then it have problems meeting payroll and a very real possibility of losing contracts and clients. In this case, a solution is to get an advance on the invoice by factoring with an invoice factoring firm.
In a invoice factoring transaction, the factoring company advances funds against an invoice. The advance is usually 70% to 90% of the invoices and varies by industry. The advance provides working capital that enables the owners to meet payroll and other business expenses. Once your client pays the invoice in full, you get the remaining funds, less the factoring fee. The fee varies based on a number of parameters but can range from 1.5% to 4.0% for an invoice payable in 30 days.
Qualifying for invoice or accounts receivable factoring is relatively easy, when compared to other business financing products. To qualify, the company must be in good standing, free of any liens and have a roster of good paying customers. Invoice factoring companies consider your invoices to be your biggest asset and are very happy to use those as collateral. That makes their services accessible to companies of all sizes, including start ups. More importantly, it provides funds to companies whose biggest assets are a good reputation and a list of solid clients.
What you Should Look For In A Invoice Factoring Company
Invoice factoring companies are companies that fully manage a business’s sales ledger, and ensure collection of all the debts due. Invoice factoring companies buy invoices or receivables from a business and advances 80 to 90 percent of the invoice amount. The remaining amount minus the charges will be paid when the customer clears the debt. The invoice factoring company takes the responsibility of informing the customer about the service. The seller receives the amount within 24 hours in most cases.
Invoice factoring companies are advantageous to businesses in that they provide the working capital needed when the clients fail to pay on time. They demand no collateral and are therefore hassle free.
Invoice factoring companies gain from the service charge and the interest charge for the cash advanced to the business. The service charge is usually a certain percentage of the sales factored and the service charge is calculated usually depending on the annual turnover of the company, the number of invoices and the number of customers. The interest charges are along the lines of normal secured bank overdraft rates. Some invoice factoring companies provide bad debt protection whereas some do not. While this is termed non-recourse factoring, recourse factoring is the policy when the bad debts remain with the business.
Invoice factoring companies are a large group, existing as units within many commercial banks, as sections of large financial institutions, as companies, and as services offered by individuals. When choosing a factoring company, extreme care is to be taken regarding its terms and conditions, reputation, service, bad debt protection, service and interest charges. It is also best to verify whether the company chosen provides Internet access to one’s account so that the sales ledger and customer details can be constantly monitored. It is also crucial to ensure that they promote a good customer relationship.
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