How Invoice Factoring Works For Businesses
Invoice factoring can be categorized as a funding solution that converts invoices into immediate liquid cash for businesses. In most cases, factoring agencies usually pay in two installments for the invoices: an advance of roughly 80% of your invoice and the remaining 20% after the invoice is paid. You will have to pay factoring fees to the factoring agencies for their services though. Invoice factoring is particularly helpful to small business owners who may not qualify for traditional loans or who aren´t too keen on taking out loans. This funding solution is quite common in the manufacturing, construction, and transportation sectors.
Before we discuss how invoice factoring works for businesses, it is essential to first understand how it works. In most cases, there are five steps involved in invoice factoring.
- First Step
The first step involves you issuing an invoice to your customers for them to pay you. For any factoring process to be accepted, the invoices must be payable within 3 months.
- Second Step
After that, you should find a factoring agency you want to work with. You will have to fill out a few application forms. Then, you can sell the factoring agency all of your outstanding invoices. The factoring agency goes through your application and determines if it is in their best interest to pay for your invoices.
- Third Step
If the factoring agency decides to work with you, you will be given an advance of around 80% of the value of the factored invoice. Then, the factoring agency will most probably send out a “notice of assignment” to the clients you have chosen to factor, or they may ask you to do so.
- Fourth Step
Your client then pays the factor within 3 months according to the terms of the invoice.
- Fifth Step
After the factoring agency receives the full amount from your client, the factor then releases the remaining balance of the invoice, minus their fees.
In a nutshell, invoice factoring works best as a quick solution for short-term cash flow problems. Here´s how invoice factoring can be particularly helpful to businesses;
- Invoice factoring helps businesses manage cash flow dips
Some businesses solely rely on day-to-day finances and daily cash flow to survive and grow. This is largely the case with startups, small and medium-sized businesses. Many of these businesses often find it difficult to remain operational when they have to wait several months for a client to pay them. Luckily, invoice factoring, as we have mentioned before, gives the businesses immediate access to liquid cash for ongoing and urgent needs, such as employee payment funds and inventory, and even for more strategic and calculated moves. Invoice funding gives you the funds to make your payments on time, fulfill your tax obligations, and take advantage of early payment discounts.
Basically, you will not have to wait for months to get paid as you will have immediate access to the funds that you have already earned. You will be able to steady out the cash flow dips to create a balanced cash flow. Your won´t have to worry about your expenses and you will be in a better position to expand your business operations.
- Invoice factoring helps you take on big opportunities
Invoice factoring isn´t only for plugging short-term gaps. The funding solution can help you take on huge opportunities, especially those that help your business expand exponentially. For instance, let´s say that your business comes across a potential new customer, a big company. However, taking on the job would require using three months of your income. In most cases, businesses shy away from taking such huge, risky jobs. Fortunately, with invoice factoring, you won´t have to back out of such opportunities. You can take on the job without worrying about funds for various needs and for other small jobs. Thus, you will not only be able to maintain your current customer base, you will also be in a position to take on big jobs that can help your business expand tenfold.
- Invoice factoring helps you invest in your business
When you have immediate access to liquid cash, you will be able to address short-term needs and requirements with ease. Invoice factoring releases the cash-flow tied up in invoices, allowing you and your business to pay bills and suppliers, and purchase stock and inventory. Now, this also helps make it easier for you to focus on long-term, strategic goals. However, you need to work with a financing company that offers flexible and transparent terms. After all, there isn´t a dearth of invoice factoring companies that use confusing fee structures and set stringent terms.
- Invoice factoring agencies take your burden of collecting payment
When you get into bed with invoice factoring providers, you not only gain immediate access to liquid cash, you also get access to a team of financial professionals who take the burden of collecting and processing payment on invoices, which ultimately leads to a reduction of overhead costs, freeing up both you and your staff members for tasks that require immediate attention, allowing you to maintain your focus on your core business. By reducing stress, the immediate cash flow allows you to focus on tasks that are more profitable.
- Other benefits
Qualifying for a bank loan can be challenging, to say the least. However, since invoice factoring is not a loan, it is far easier to access immediate cash through invoice factoring than through obtaining loans. In addition to that, you also won´t have to put up any collateral to qualify for invoice factoring, making it a much lower risk borrowing option than many of its counterparts.
Factoring agencies don´t need you to have a good credit history either as they largely only focus on the creditworthiness of your customers. And since factoring is not a loan, you won´t be racking up any debt, which allows you to keep your balance sheet looking good.