What is invoice factoring? Invoice factoring also known as accounts receivable factoring is a monetary transaction whereby an enterprise trades its outstanding invoices to a different factoring company at a concession. Businesses that sell to the government or other businesses use factoring to evaluate their immediate cash flow. Invoice factoring & invoice financing are normally used interchangeably. For this reason, one might mistake them to mean the same thing. However, the two are fundamentally different. Invoice factoring is the process of selling an asset, while invoice financing is essentially a loan that uses invoices as its collateral.
The step-by-step process of invoice factoring
In case you have an interest in factoring, but are not sure how to start, the following is procedural guide for the process:
Conduct a review of various factoring services and select the best option for your enterprise needs.
Fill in the requisite details within the invoice factoring application.
Give the factoring agency some time to review your details and decide whether to make an offer or not.
Go through the offer’s terms and decide if you would like to proceed.
Sign all the required paperwork in agreement of the terms & conditions.
Submit your invoices to the factoring agency by fax or through electronic means.
Let the factoring company undertake a random verification of some invoices.
Inform your clients that you are dealing with a factoring agency.
Accept the advance offered by the factoring company. This is usually 80-90 percent of the invoice face value.
Wait for your clients to make payments for their invoices. Based on your terms, the process might take between 30 to 90 days.
Receive the balance of the invoice’s face value after factoring company has deducted the fee.
Even though these are the primary steps, there are some details and procedures that might vary from one firm to another. For instance, there might be different types of fees charged.
When is it appropriate to turn to factoring?
Businesses normally seek factoring services when they require additional working capital, yet they have a lot of revenue tied up in accounts receivable. For instance, assume that you are running a wholesale food distribution and supply company. Most of your clients are restaurants who make payments on net 60 terms. This means that you send them invoices for their orders, and they make payments within 60 days. However, in a certain month, your warehouse’s refrigeration system breaks down. In order to repair it, you need funds as soon as possible. Instead of taking a loan, you resolve to obtain factoring services to convert your accounts receivable into cash. Such a scenario is just a single example on why a business might opt for factoring. However, the gist is that enterprises can utilize small-business invoice factoring whenever they need quick cash.
Industries in which business factoring is commonly used
Invoice factoring is majorly used by businesses that use invoices when dealing with clients. As a general rule of thumb, factoring agencies generally give preference to clients who undertake business-to-business sales. This practice is also common within the construction industry. Contractors tend to involve their clients, but also have to deal with the purchase of materials and paying staff as they work on their projects. Whether it is a large construction firm or an independent contractor, these professionals might resort to factoring in the event that they need a cash injection. Furthermore, enterprises such as accounting and law firms that offer professional services to other companies can also use factoring.