In simple terms, invoice factoring — also known as debt factoring and accounts receivable factoring — is a unique form of financing where you sell a select number (or all) of your company’s outstanding invoices in exchange for immediate funds. From there, the factoring company collects payment in full directly from your customers, retaining a percentage as their fee.
HOW INVOICE FACTORING WORKS
While the invoice factoring process varies slightly from company to company, here’s what you can expect:
You provide your customers with a product or service.
You send the invoice to the factoring company instead of your customer.
The factoring company pays you a percentage of the face value of the invoice, up to 98 percent of the total amount.
The factoring company sends the invoice directly to your customer.
The factoring company seeks payment directly from your customer.
The factoring company pays you the remaining amount due, less their agreed-upon fee.
Before entering into an agreement, discuss the terms and conditions with your factoring company
THE BENEFITS OF INVOICE FACTORING
Just the same as any form of financing, there are both pros and cons of invoice factoring. Let’s start with the benefits:
More predictable cash flow: When you wait for your client to pay you, you’re at their mercy. Even if you have a contract that clearly outlines the payment terms, it doesn’t always mean they’ll respect it. By invoice factoring, you can receive payment immediately rather than waiting for your client. This allows for a more predictable cash flow, which can help grow your business.
Easier to obtain than a bank loan: There are times when a bank loan makes sense, but it’s no secret that they’re both difficult and time-consuming to obtain. Invoice factoring is easier to obtain than a bank loan, thanks to stream-lined application and funding processes. The primary requirement is proving that your invoices are valid.
Less time on debt collecting: Invoice factoring takes debt collection out of your hands. Your factoring company takes on this responsibility in exchange for a fee. This leaves more time in your schedule for other tasks.
Long-term financial savings: Upfront, it’s easy to assume that invoice factoring will cost you money. And while that’s true, there’s the potential for long-term financial savings. For example, you can get by with a smaller accounts department. You can also save money as you don’t have to pass off past-due invoices to collections.
Even though some disadvantages of invoice factoring exist, there are ways to combat each one. For example, if you’re concerned about high fees, talk to a factoring company like REV Capital about the options that are available to you. Or if you’re concerned about a long-term contract, negotiate more favorable terms.
If growing your business is a long-term goal of yours — and it probably is — invoice factoring deserves your full attention. Here’s why:
No debt: Unlike a bank loan, you don’t take on debt with invoice factoring. You pay a small fee in exchange for immediate payment of invoices.
Fast access to cash: The longer it takes to access the money that’s owed to you, the more difficult it is to keep up with your growth goals. You need money now for expenses such as equipment, marketing, advertising, and inventory.
Time is money: Without invoice factoring, you’re responsible for all functions pertaining to accounts receivable. With that, your accounting department can quickly bog down. And the more time they spend chasing invoices, the less time they have for other tasks.
When combined with the benefits above, invoice factoring puts you in a position to grow your business at your pace. You’re no longer at the mercy of your clients.
INVOICE FACTORING: AN EXAMPLE
Now that you understand the ins and outs of invoice factoring, let’s look at an example of how it works.
Invoice Face Value: $100,000
Factoring Fee (3%): $3,000
Initial Advance (80% of invoice value after fee): $80,000
The remaining balance owed: $17,000
Total received: $97,000
Note: These numbers can vary from one invoice factoring company to the next. The two primary details that can change include the factoring company fee and the initial advance.
With a variety of benefits, there’s no wondering why so many companies rely on invoice factoring to grow their business.