Understanding Factoring Invoices: A Beginner’s Guide

There are two primary methods to obtain funding for your business.

You could go the traditional way of applying for a conventional business loan or explore ingenious strategies like invoice factoring.

Here’s everything to know about invoice factoring, including how the process works and its benefits over regular business loans.

Unpacking Invoice Factoring

Invoice factoring is a business funding model in which a company sells part or all of its outstanding invoices (accounts receivables) to a third party. The primary reason behind factoring invoices is to obtain quick capital to address cash flow issues.

Invoice factoring is a popular Financing Method for Businesses that may not easily access conventional loans due to barriers like poor credit scores.

There are many other benefits to accrue by selling your accounts receivables to another company, as you shall find out.

Invoice Factoring versus Invoice Financing

Many entrepreneurs confuse “invoice factoring” with “invoice financing.” But although they’re often used interchangeably, the two terms are fundamentally different.

Invoice factoring entails selling your accounts receivables to a third-party entity, while invoice financing is a conventional business loan that uses your outstanding invoices as collateral.

Invoice Financing typically involves mainstream lenders, such as commercial banks and micro-finance institutes. For comparison, an invoice factoring company isn’t necessarily a lending firm.

Parties in an Invoice Factoring Deal

An invoice factoring arrangement involves three primary entities.

First, there’s a business that has racked up a considerable amount of accounts receivables and is willing to sell those accounts for quick cash.

The second party is a factoring company that’s willing to purchase outstanding invoices.

Lastly, there are one or more debtors.

Benefits of Invoice Factoring

1. Improves Cash Flow

Better cash flow is the primary factor most businesses factor into their invoices. This funding model provides instant payment to most (or all) of your accounts receivables rather than waiting until your customers pay up.

The cash advance received from a factoring company can go into meeting ongoing business expenses, such as paying employee salaries and settling monthly bills.

2. Lets You Bring In More Inventory

Besides catering to ongoing business needs, you could also expend the money received from an invoice factoring company to acquire fresh inventory. Having fully stocked shelves minimizes the risks of losing important customers to your competitors.

Invoice factoring may also avail the capital required to procure business equipment. An alternative financing method would be to obtain conventional equipment loans, which are notorious for their high interest rates.

3. Spurs Business Growth

The money obtained from invoice factoring can help to stimulate business growth. Since you have adequate cash at hand, you could easily expand to unentered markets.

Note that entrepreneurship is all about leveraging available opportunities before everyone else does. With the cash advance from invoice factoring, you can upscale your business by providing better goods and services than your competitors.

4. Keeps Your Business Healthy

Statistics indicate that over two-thirds of all startups do not realize a return on investment (ROI), with the vast majority failing within five years. As you might have guessed, poor cash flow is a leading reason why many businesses don’t break even.

Since invoice factoring addresses cash flow problems, this funding mechanism can keep your business afloat during harsh economic times. Just ensure you use the cash advance for the intended purpose.

5. Aids Business Planning and Forecasting

Planning is a critical business process. It lets you predict key growth aspects, such as stock turnover and revenue generation.

However, it’s difficult to plan when your business is grappling with cash flow issues. A simple emergency could easily throw your plans into disarray, crippling every other operation.

Invoice factoring ensures that you have money when you need it. You can utilize the funds to make long-term business arrangements, which would otherwise wait until your customers pay up.

6. Easier To Obtain Than Conventional Loans

The invoice factoring process is easier to navigate than traditional loans.

Most factoring companies won’t need you to have a solid credit score. Their primary concern is validating the authenticity of your accounts receivables.

Besides, invoice factoring requires no collateral. So, there are zero risks of losing your business assets if something goes wrong.

A Step-by-Step Guide to Invoice Factoring

• Your business provides goods and services to its clients in the normal way
• You invoice your customers for the delivered goods and services
• You identify a need for invoice factoring, perhaps due to cashflow problems in your business
• You find a suitable factoring company
• The factoring company verifies the validity of your outstanding invoices and then pays for most of them upfront (typically 80% – 90%).
• The company then chases your clients directly for payments
• The factoring company pays the remainder of the invoiced amounts, less any fees

Summary

Invoice factoring provides quick access to uncollateralized business financing. It’s an excellent funding mechanism for companies with a low credit score to obtain capital on short notice without being tied down by stringent lending terms.

The only noteworthy challenge with invoice factoring is finding a suitable factoring company.

Proper research is necessary to locate a firm that’s willing to pay all or most of your outstanding invoices upfront.

It’s also prudent to establish a company’s reputation before entering an invoice factoring partnership with them. Insist on a business that can go after your debtors patiently and professionally to avoid losing valuable clients.

Tags: factoring invoices, Invoice financing, Return on Investment