Invoice factoring is a financial transaction and a type of debtor finance. In an invoice factoring agreement, a business sells its accounts receivable (invoice) to a third party (called a factor) at a discount. A company will often factor its receivable assets to meet its present and immediate cash needs versus waiting for payment based on original contract terms. Factoring invoices is also used to mitigate credit risk.
Factoring is also referred to as accounts receivable factoring, invoice factoring and sometimes erroneously accounts receivable financing. Accounts receivable financing is actually a form of asset-based lending (ABL) utilizing a company’s accounts receivable as collateral.
How Does Invoice Factoring Work?
- Your company provides goods or services to larger creditworthy customers and submits invoices.
- Your company needs to be paid sooner than agreed terms (i.e., 30-90 days) with your customers.
- Your company sells its unpaid invoices to an invoice factoring company per a factoring agreement.
- The factoring company verifies the invoices are valid and your company receives up to 90% of the invoice amount from the factor. Once the account is set-up payment can be received within 24 hours.
- The larger creditworthy customers make payment directly to the factoring company according to the terms of the invoice. The factoring company then pays the balance of the invoice back to your company minus a nominal fee.
How is Invoice Factoring Different from a Bank Loan?
When understanding invoice factoring, it is essential to remember that factoring differs from borrowing in that companies sell accounts receivables rather than using them as collateral. The net result is that your company can convert its receivables into immediate operating cash. That way, you will not have to wait 30, 60, 90 days or more for your customers to pay.
Non-recourse factoring offers the added benefit of protection against insolvency or bankruptcy. Only the best, most experienced factoring companies are able to offer non-recourse factoring to their customers. This is especially important in today’s economic environment of uncertainty. Expect the unexpected as business owners must be diligent in protecting their own interests and livelihoods.
The factoring process places the time, cost and effort of the collection into the hands of the factoring company Factoring allows you the time to concentrate on what you do best – run your company. Your business receives the cash it needs when it needs it, so you can best manage your business.
Invoice factoring can be an excellent option for companies that need money quickly but aren’t able to secure a conventional bank loan. Factoring companies will research the credit history of the seller’s customers before purchasing the invoices. Factors will want to be confident that these companies have a history of paying their bills.
Invoice factoring is a great way for companies to infuse cash into their business without taking on additional debt. Receivable finance is a great funding option for most industries including staffing, manufacturers, distributors and importers.