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What is invoice factoring?
Invoice factoring enables companies to sell any unpaid invoices (accounts receivable) to a third party (a factoring company). Subsequently, the factoring company takes on the responsibility for collecting these payments.
Money received form invoice factoring can be used for any purpose — like restocking, paying bills or business expansion. Essentially, this form of finance is a substitute for more traditional banking loans, credit cards or overdrafts.
Forfaiting and factoring are similar ways of financing international trade transactions. The key difference is that forfaiting is focused on long-term receivables and capital goods — while factoring is concerned with shorter-term receivables and ordinary goods (and services).
Invoice factoring — considerations
Invoice factoring is designed to help businesses with working capital and cash flow problems — particularly businesses that may have long customer payment terms. By selling your debtor book (invoices) to a factoring house, you can access vital cash — before customers actually pay for your goods and services.
Invoice factoring can also be used by companies that simply want to grow — without worrying about chasing people for payment. Factoring frees up your time, as a third party team — does the credit control for you.
Invoice factoring companies (factors) do not purchase invoices at full face value — instead they purchase them at a discount. Depending on the relationship you have, funds from sold invoices can be released in a matter of hours — with processes being quicker with online debt factoring companies.
In contrast to invoice discounting, invoice factoring sees you handing over your sales ledger to a third party — who then deal with your customers directly. Lenders often prefer factoring, as they are able to directly influence how quickly customers make payments i.e. it is seen as lower risk by the lender. Companies with lower turnover and shorter trading histories — will likely only be offered factoring facilities.
Invoice factoring has grown in popularity in recent years, as it has become more and more difficult for companies to get much needed financing — from conventional banks.
How does invoice factoring work?
After finding a suitable factoring facility, with a lender, you would raise an invoice. With some lenders, this invoice will be uploaded onto a secure online portal — while others will ask you for an email and/or a physical copy.
With most lenders — the advance you will get is usually around 80% of the invoices total value. From then on, the invoice company would be responsible for credit control — contacting customers on your behalf, when bills are due to be paid. Where customers fail to make payments — lenders can take legal action.
After a customer has paid — the money goes into the factoring company’s account. You would then receive the remaining invoice value — minus any service and factoring charges.
With this lending facility — your customers would normally know that you are making use of a factoring provider.
Before agreeing terms with a lender — you would be given the option for a recourse or non-recourse facility. A recourse facility sees you responsible for the costs of any unpaid invoices — while a non-recourse facility sees the lender absorbing the costs of any default. Accordingly, non-recourse is also known as “bad-debt protection”. Non-recourse facilities come with extra costs — as the lender takes on greater risk.
Benefits of invoice factoring
- Access to financing for business growth
- Cash released quickly
- More time to focus on your business
- Can borrow as much as you invoice
- Can extend customer payment terms
- No collateral required
Limitations of invoice factoring
- Short-term finance — higher fees
- Lose control of some of your sales ledger
- Can be unsuitable for businesses where customer relationships are key
- Facility only offered on commercial invoices — of reputable organizations
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