It is common for most businesses, regardless of their lifecycle stage, to seek non-traditional ways when looking for financing options nowadays. Factoring is one of the most popular solutions that companies use as an alternative to bank loans. In fact, Factoring, also referred to as Account Receivables factoring or Invoice factoring, can be a great funding solution for any business looking for instant funds to fulfill its strategic goals and/or daily activities. However, the concept of invoice factoring is often misunderstood by businesses that come across it for the first time or those who had the misfortune to obtain their information from the wrong source. Let’s explore the Invoice Factoring together.
What is Invoice Factoring?
Invoice factoring, a type of debtor finance, is a financial agreement in which a factor accepts to buy a business’ invoices at a discounted price. The factor provides an upfront payment to your business depending on the due amounts from your verified creditworthy invoices. After 30, 60 or 90 days, the factoring company receives the debt from the end customers and returns the remaining balance to your business after applying the agreed service fees. Thus, Invoice factoring allows your business to have enough working capital so as to support your operations.
For example, a Consulting Company needs funds at a fast rate for its immediate financial needs. The company contacts a factoring utility offering to sell a number of creditworthy invoices worth $100,000. The factoring company accepts to buy them for 90% of their value, meaning $90,000. In accordance with the original terms of the invoices, the factoring company will collect the money on due dates and return the money to Consulting Company after subtracting the service fees.
How does Invoice Factoring work?
Invoice factoring can be a great alternative solution for any business that hasn’t got or has already consumed its credit line. If your business is in a critical situation, meaning you are lacking funding options and have pressure to fulfill orders, Invoice Factoring will help you cover your financial needs as it can quickly and effectively provide you with enough working capital for your cash flow needs.
AR factoring works as follows:
- Your company contacts the factoring company and enjoy a cost-free, easy application process;
- Your company submits all or some of its good invoices to the factor;
- The factor verifies the invoices and your customers’ creditworthiness;
- The factor can offer to you, depending on your industry, up to 90% of the value of the invoice;
- Approval can take as little as 24 hours as the focus is not on your personal credit score;
- The factor notifies your customers that they are liable to pay him and not your company in due time;
- After 30, 60 or 90 days the factoring company receives the invoices’ payment;
- Once payment received, the factor applies its fees and send you back the remaining balance.
How is a Factoring Company different from a Collection Agency?
At first glance, factoring companies and collection agencies may look quite similar as they both seem to provide unpaid invoices collection services. However, a factor and a debt collector operates differently and give unique services for a non-paid completed work.
It’s vital, as a business owner, to understand the difference between these two services and how each one of them works. Invoice Factoring is not a collection service.
The factor buys your creditworthy, good invoices at a discount by offering an upfront payment of the accounts receivables worth to bridge the gap between your immediate needs and the payment’s due date.
The debt collector takes charge of your business’ old owed debts to retrieve the money through a series of letters, emails, phone calls and other legal processes to receive full payment. Many times, collection agencies are law firms or have lawyers on staff.
The difference between a factoring company and a collection agency can be established in five major keys:
- Purpose: Factoring is an alternative financing solution aimed to improve your working capital, whereas a collection agency is aimed to attempt an old debt recovery.
- Process: The factoring process is simple. Once you submit invoices to a factoring company, they verify and confirm the invoices’ details with the debtors along with checking their creditworthiness. Once approved, your business is funded in as little as 24 hours. However, debt collection is generally a tedious process. A debt collector oversees recovering owed debts without ruining current business relationships and while adhering to the Fair Debt Collection Practices Act. The collection process typically starts by communicating with the debtors regarding the delinquent debt through phone calls, followed by frequent written correspondence and reminders to push the debtor to cover the debt. If the debtor defaults, then legal action is initiated.
- Current Invoices VS Old Debt: Factoring companies only buy current accounts receivable. Your invoices should range from newly generated to those that have been billed for no longer than the past 30 days. Collection agencies will accept to take on your much older invoices; 90 days or even older.
- Fees: Factoring companies charge their clients an average service fee of 2%-3% of the value of approved invoices. The cost of factoring is minimal as clients’ creditworthiness is checked before approval. Debt collection agencies, in contrast, charge an average service fee of 25%-30% to recover an unpaid debt depending on the age, risk, and nature of the debt.
- Funding: Factoring allows you to receive your owed money in advance, meaning that it is aimed to free up the capital that is stuck in unpaid debts. A collection agency is aimed to recover your old debts when your clients default to pay at due times.
What are the benefits of Invoice Factoring?
Invoice factoring allows any business not only manage its cash inflow and daily activities but also invest in growth opportunities. Also, AR factoring provides an alternative option when difficulties occur to obtain other means of funding. To sum up, the benefits of invoice factoring are:
- Fast access to cash;
- Flexible negotiable terms;
- Reasonable service fees;
- Professional receivable management and industry experience;
- Based on your clients’ creditworthiness, not your own credit line;
- Provides free back-office support;
- Factoring is not a loan, meaning less debt on your balance sheet;
- Funding grows as your receivables grow.