What Is Invoice Factoring All About?
Okay – it’s about time we got a good understanding of what invoice factoring is and how it works. One of the most appealing definitions of factoring is “a non-debt solution to cash flow needs”. It is literally money at your fingertips. Factoring is a creative way to finance a business.
We can describe factoring as the selling of a company’s accounts receivables or invoices to an investor, private lender or bank who can pump cash into the business. It literally lets the company operate as if it were a ‘cash on delivery’ business, while simultaneously letting its customers enjoy credit terms.
The basis for the availability of funds is the customers’ (debtor) credit worthiness, along with the number of valid invoices. Note this. It is not the credit worthiness of the business itself, unlike in bank financing. Therefore, the more business the company generates, the more money it can access. Factoring does not involve the signing of lengthy long-term contracts. In certain factoring facilities you can control when and how much to factor.
Thanks to factoring, the business can now do what it is meant to do – manufacture, sell and deliver their products or services to their customers.
The process of factoring is a simple one. The business chooses an invoice and puts it up for approval to a factoring company. After the invoice is verified, the funds are released to the business. That is it! As a rule, around 60-85% of the value of the invoice is provided as funds. If the business has provided a 30-day credit for its own client, the factor collects it after 30 days and hands it to the business for a nominal fee. This fee varies among factoring companies and depends on volume of business and the credit terms offered by the business.
In the context of factoring, let us also look into production financing and contract financing briefly (this will help us understand what is NOT factoring or factorable):
Is available to manufacturing businesses that need the extra funds to handle unexpected demand. Here the financing is provided based on how much the business needs to produce, insure and deliver. It is not based on the invoice amount. Here the fees are higher than in factoring. Unlike factoring, the amount of funds is also lower because the risks are seriously greater.
Is meant for non-manufacturing companies that use contract manufacturing to fulfill orders from international and national clients. This financing is not for building up inventory; rather it is only to fulfilling orders. As with production financing, the funds are low and fees are high. You can identify a factoring opportunity here that can be used to pay off the purchase order financing after the order is fulfilled. Purchase order financing is popular with import and export companies.