The term invoice factoring refers to a certain type of financial agreement than helps smaller businesses accelearate their cash flow by selling their invoices to a factoring company that will chase their outstanding payments for them.
How factoring works
Factoring occurs when a business chooses to sell all of its unpaid invoices to a third party – the ‘factor’. The factor will then take on the recovery of these payments, providing the business with a down-payment on the value of their invoices, in exchange for a service fee.
It is an effective way of using your outstanding invoices to quickly bring in money that could be used to pay off any large or small debts that you may have incurred. In a way, factoring could be seen like a bank loan of sorts, but with a few notable differences.
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The main differences between invoice factoring and bank loans
There are three main differences between invoice factoring and bank loans:
- It is important to note that invoice factoring is not actually a loan. A factoring agreement does not have the same rules and regulations that go along with a bank loan and does not incur the same kind of debt. It is simply a purchase of the outstanding invoices of a business.
- When taking out a bank loan, your business will have to prove its credit worthiness to the bank in order to borrow the money. This is not the case with invoice factoring, as the value of your invoices is of greater importance.
- The third and final difference is that bank loans generally involve two parties – the business or individual attempting to take out the loan and, of course, the bank. With invoice factoring, your own customers are also involved, making the process a little bit more complicated as their credit rating will be more importance to the factoring company than your own. Indeed, some of your clients – and in turn, your invoices – may not quality for funding.
The Three Parties involved in the factoring of invoices
As was mentioned above there are three parties involved in invoice factoring as opposed to two with bank loans. These parties are as follows:
- Your business – the seller of the ‘receivable’. This is basically a financial asset often associated with the debtor’s liability to pay money owed to the your company. This must be for goods that have been already been sold or work that has been completed.
- Your customers – the ‘debtors’, inevitably is the business or individual that is required to pay for goods provided by your company.
- The factor - the specialised financial organisation that the you will be selling you invoices to, often at a discounted rate in order to get the cash that you require. At this point your invoices – also known as ‘the receivables – are transferred to the factor, who will then chase the debtor for payment.
It is also important to note that the factor obtains the right to receive any payments that are made by the debtor for the amount stated on the invoice and in certain cases will also bear the loss if the debtor refuses to pay the amount on the invoice. Other factoring companies will refer these ‘bad debts’ back to you, thus reducing the amount of funds you can draw in the future.
Be sure to get the best factoring rate for your business by getting free quotes for the factoring of invoices from Companeo.
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