The accounts receivable can be the most vulnerable part of a business whether the company is small or large. For example, most companies ensure their equipment, their plant, and their assets. Yet, they do not ensure their sales ledger, which can represent on average 40% to 45% of their assets. As a result, blue-chip companies such as Worldcom, United Airlines, General Motors, Kmart and Lehman Brothers were faced with bankruptcy, which stung many small vendors.
Thankfully, there is a way for companies to protect themselves against the risk of the customer not paying. Invoice factoring can be not only a great solution to your cash flow management but also to your credit insurance.
How does invoice factoring help small business?
Factoring also referred to as Accounts Receivable factoring, AR factoring or Invoice Factoring is a financial transaction in which a business sells its invoices/accounts receivable to a factoring company at a discounted price. Factoring companies bridge the gap between delayed payments and urgent needs for you, as most of the invoices you generate are typically due in 30, 60 or 90 days. You factor will offer you an upfront payment depending on the amount due from your good invoices and your industry.
In fact, the factoring company will evaluate your accounts receivable creditworthiness and then offer you a fast advance payment that would boost your cash flow and provides you with working capital. Your customers will then receive a notification that on due dates. The debt will be collected by the factoring company and your business will receive the remaining balance minus the already procured amount and the factoring service fees. Therefore, invoice factoring ensures you have a steady cash flow and enough working capital to manage your daily operations and cover your immediate needs.
For example, Furniture Company contacts a factoring company in order to sell its creditworthy invoices, due in 60 days, and worth $100,000. The factoring company accepts to buy them for 90% of their value, meaning $90,000. According to the original terms of the invoices, the factoring company will collect the liable debts in 60 days from Furniture’s customers and return the remaining $10.000 balance to the company after subtracting the factoring service fees.
Invoice factoring works as follows:
You are a B2B or B2G business;
Your business has immediate needs and lacks working capital;
You contact the factoring company and enjoy a cost-free and straightforward application process;
You choose to submit your creditworthy invoices to the factoring company;
The factoring company verifies the invoices’ creditworthiness and your customers’ satisfaction;
The factor can offer you an upfront payment, depending on your industry, up to 90% of the invoices’ value;
Same day funding as approval can take as little as 24 hours;
The factoring company notifies your customers that they will collect the debt from then on due dates;
On due times, the factoring company collects the debts in accordance with the initial terms of the invoices;
Once payment received, the factor gives you back the remaining balance minus the service fees.
What is the difference between trade credit insurance and factoring?
Trade credit insurance is for short-term account receivables, due within 12 months. Trade credit insurance protects your business against risks that are beyond your control i.e. commercial, political… It minimizes the risk of sudden or unexpected customer insolvencies along with improving your access to cash so that you have the confidence to extend trade credit to new customers. In fact, trade credit insurers insure you against the risk of non-payment as well as offer you additional services including collections services, portfolio assessment, securitization…
On the other hand, a factoring company buys your accounts receivable and offer some of the activities of the credit department. By factoring all or some of your creditworthy invoices, you are not only ensured payments to cover your operational costs with shorter terms but also an optimization of your current assets and liabilities along with a cover against your customers’ bankruptcy. However, a factoring company does not cover you against non-payment on its own. Usually, factor companies partner with trade credit insurance companies in order to provide you with this cover.
How does invoice factoring involve credit protection?
Factoring companies bolster the security of the debtor book as they seek to cover the debtor against insolvency by offering a non-recourse factoring service. As the name suggests it, is without any recourse to the client if its customer defaults. Non-recourse factoring assumes that the factoring company takes the risk in case of non-payment; meaning that you are not to be liable to repay the factor if your customers fail to pay.
It is the factoring company that is in charge and will have to take action if your clients default and fail to meet payment on the agreed due times. In fact, the factoring company will proceed by underwriting an individual credit limit on each of your customers. Also this will accept the bad debt loss in the event of the insolvency of that customer in accordance with the initially agreed limit. This way, when your business factors its invoices, you also take advantage of credit insurance or bad debt protection.
What are the benefits of invoice factoring?
Invoice factoring will not only improve your cash inflow. Instead, this provides you with continuous working capital by releasing up to 90% of your invoices’ value. The release of your cash can be in as little as 24 hours. Aside from that, there are also hidden benefits that can be cited as follows:
- Represents an inclusive protection against bankruptcy,
- No extra debts;
- Not liable for covering the cash advance for unpaid invoices;
- A factor is at risk for bad debt;
- Supports sales expansion;
- Allows further credit arrangements;
- Improves customer relationships;
- Possibility to extend trade credit to new customers.
At BusinessCash.com, you can have access to credit insurance policies as part of our Invoice factoring package. We already have our own credit protection policy. Meaning that your receivables are also protected under our policy at no extra charge to your company. Many do not realize this hidden benefit.