What is Invoice Factoring?

business owner worrying about past due invoices

Many banks have either tightened their credit standards or put a freeze on new business loan transactions, while they assess the impact the COVID-19 pandemic will have on their loan portfolios. Whether your bank turned down your loan or has cancelled your A/R line of credit, you can quickly improve your cash flow by using Invoice Factoring.

Invoice factoring is a form of asset-based financing. It is a quick and flexible source of funds for businesses that are waiting for outstanding receivables to be paid. An invoice factoring company uses your accounts receivable as the collateral and advances funds against the face value of your invoices. In addition, invoice factoring allows your credit line to grow proportionately with your sales cycle. Funding amounts range from as little as $10,000 per month to $5 million or more for larger companies.

Invoice factoring can provide a quick solution for cash flow problems.  Companies that do not meet traditional commercial lending requirements but have good quality accounts receivable outstanding are great candidates to use invoice factoring.

How Does Invoice Factoring Work?

Invoice factoring is the purchase of your accounts receivable invoices at a discount for a lump sum. Advance rates range from 70% to 85% or more of the invoiced amount. If you sell products or services to businesses that pay you in 30, 60, 90 days or more, there is an invoice factoring solution for your business.  It will typically generate cash within a day of invoicing. Initial approval and setup with a factoring company can take 2-3 days.

One example of how invoice factoring is used are staffing companies. They bill their customers weekly and run payroll for their employees weekly also, but their customers pay in 30-60 days. They use invoice factoring as a payroll funding mechanism.

The Factoring Process:

Factoring is a simple extension of your current accounts receivable process:

  • Following your normal course of business, you sell your product or service to a customer, and issue an invoice for the value of the goods or service.
  • To factor the invoice, you follow the sale by sending the factor a copy of the invoice(s).
  • The factor processes the invoice, and within 24 hours, the factor gives you a percentage of the invoice amount, called an advance payment. This is the first of two payments you receive when factoring an invoice.
  • The customer, when ready to make payment, sends their payments direct to the factor.
  • When payment is received, the factor subtracts its original advance plus the interest expense.  They then return the difference, or reserve back to you.
  • The reserve is the second payment you receive from the factor for the invoice.
  • Repeat the process for more cash flow!

The Benefits of Invoice Factoring:

  • Increased Cash Flow – Cash tied up in accounts receivable is now in your hands to fuel business growth. You no longer need to wait 30, 60, or 90 days for payment.
  • Faster Growth – Eliminating the need to wait for customers to pay speeds up your business cycle. You now have the ability to expand the business and purchase needed materials, pay vendors, and cover payroll and operating expenses. Without factoring, you would have to turn away additional business due to your lack of cash flow.
  • Improved Financial Position – Factoring frees up cash for you to reinvest in your company and reduce debt.
  • Combat Seasonality – Factoring allows you to smooth out cash flow peaks and valleys.
  • Flexibility – You decide how much and how often you want to factor. The amount of capital available from factoring can grow as sales grow, and is not limited by a company’s equity capital.

Does your business qualify for Invoice Factoring?

Invoice Factoring is available to your company even if you are:

  • A start-up with limited operating history.
  • Have a steep projected revenue growth curve.
  • Are marginally profitable or losing money.
  • Have a weak balance sheet.
  • Are in violation of bank covenants.
  • Are in forbearance or workout at a bank.
  • Need financing to pay off a traditional line of credit.

The history of the Invoice Factoring reaches back to ancient Rome. Wealthy producers and merchants employed a mercantile agent or “factor” to manage the sale and delivery of their goods. In today’s world, it is becoming more of a go-to cash flow solution. It can be used by start-up companies, fast growing companies, or companies with cash flow problems that are not able to qualify for bank financing.

Invoice Factoring is a simple and quick process. The fact that 2-3 years of operational history and credit are not the main criteria for approval make it a perfect solution for new businesses, growth situations, and businesses struggling with cash flow problems. For these businesses invoice factoring is a lifeline to success.

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