What is Invoice Finance and Factoring?
Invoice Finance or Factoring is the process of selling accounts receivable or invoices at a discount.
For the person issuing the invoice, this means immediate payment without the usual thirty, fourty-five, sixty, or ninety-day wait. The factor that buys the invoice collects the money from the business’s customer as per the credit terms agreed between the business and the customer. So let us say A is the business, B is the customer, and C the factor.
- A issues the invoice to B with a credit period of thirty days.
- C buys the invoice from A at a discount and pays A the money
- C collects from B after thirty days.
- Balance is paid by C to A
That is factoring in its simplest terms. Please understand very clearly that this is NOT a loan, so there is no question of repayment or interest charges. The invoice issued to a creditworthy customer is a company asset that is sold for a discount. This is important because loans show up as debts on your balance sheet, and you are expected to pay interest. On the other hand, factoring simply remits money into your bank without putting you in debt, as you do not have to repay it – simply because you have not borrowed the money. Instead, you have sold your assets. Naturally, this only makes your balance sheet stronger.
If you have ever applied for a loan at any point in time, you will know that loans are sanctioned based on several criteria. Your financial strength and the length of time you have been in business matter. In addition, you must produce financial and tax statements for the last three years. If you don’t meet these criteria, then the bank won’t even look at you. In such a scenario, factoring comes as a boon to small businesses that do not yet have experience to show and no credit rating to speak of, yet have many orders on hand to execute. These things are immaterial in factoring. In fact, banks are a good source of referrals for factors, when the business that applies for the loan does not meet the bank’s eligibility criteria.
So, you are probably wondering now – factoring sounds great – but at what cost? How much money you can get by selling an invoice and the fee involved depends on the factor, the industry you belong to, your customer’s creditworthiness, the credit terms you offer your customer, and the actual value of the factored invoices.