Invoice factoring is a kind of business financing in which a company transfers its credit risk to a financing company by selling its accounts receivables at a discount to the financing company. Accounts receivable is the money owed by a debtor to the company.
How Invoice Factoring Works
Three parties are involved in accounts receivable factoring: the company who wants to avail the factoring service, the financing company or the factor and the customer who owes money to the company for its products or services. Invoice factoring can be explained with the help of an example. Suppose a customer owes $8,000 to a company for any product or service and fails to pay the company within the stipulated credit period (40 days), the company can approach a factor if it wants to accelerate its cash flow. The factor will enquire into the customer's dues and transfer 80% (sometimes more) of the invoice total ($6,400), to the company's bank account within 12-48 hours. On the completion of the credit period, the company will receive the balance, 20% of the invoice total after the deduction of the factoring fee, which is n% of the original invoice total. At the end of 40 days, the factor will collect $8,000-($8,000*n)/100 from the customer. Online factoring is becoming increasingly popular.
Invoice factoring quickly releases the locked up money, thereby speeding up the cash flow. Time and money involved in collecting dues from debtors is drastically reduced. The company can make its payments on time because of the availability of funds. Credit facility can be extended to a large number of customers without the risk of creating bad debts. This will help a company to capture new markets because there is credit guarantee for new customers. Invoice factoring can improve a company's credit rating.
Factoring is within the means of most companies. Two types of payments are made to the financing company for the factoring services rendered by it: service fees and interest charge. Interest charged and factor service fee varies from company to company and time to time. The factoring service fee is usually n% of the original invoice amount.
Money is the life blood of any business. There is no specific timing as to when a company can approach a factor. Any company extending credit facility should always appoint a factor to relieve itself of the debt management.
Bankers, suppliers, customers, CPA's, attorneys and brokers can be good sources for recommending a reputed financing company. Look into the fee and the value-added services provided by different factoring companies before choosing one.