What is invoice factoring and how does it work?

posted by 4 years ago in Guide
What is invoice factoring?

If you’re unsure about how invoice factoring works and whether it’s right for your business read on for our helpful guide……..Invoice factoring is a short-term loan that makes cash owed to businesses for goods or services already provided instantly available so that they can grow.

Factor finance companies provide a solution to cash flow hold-ups by buying outstanding invoices from companies for up to 100 per cent of the value and then chase up their customers for payment. The money collected goes straight to the lender who takes out their prearranged payment and directs the rest to the company business account.

How does invoice factoring work?

Invoice factoring – also known as ‘debt factoring’ – is a package designed to enable businesses to access funds from their raised invoices before they are actually paid.

It differs from invoice discounting because the factoring company chases the funds on behalf of the borrower. This means that you give up control of your sales ledger to the factor company and that your clients or customers know that you are using this type of financing for your business.

Invoice Payment Bill Taxation Money Concept

Here’s a step by step guide to using invoice factoring:

  1. You provide the goods or services to your customers and raise an invoice with them
  2. The invoice financier will buy the debt that your customer owes you
  3. They make a percentage of the cost available to you upfront
  4. They collect the full amount from your customer
  5. They then make the remaining balance available to you
  6. You pay them interest and pre-agreed fees for using the service

Who can use invoice factoring?

Any business with short sales and long returns.

For example, recruitment agencies, construction or transport businesses. Invoice factoring appeals to any business owner who doesn’t want to wait a month to be paid for work or products they have already provided.

Factoring is also an attractive option for start-ups that may have few staff and limited administration resources. It makes freeing up cash-flow and collecting debts two less things to think about!

What paperwork do I need to produce for invoice factoring?

Invoice finance is solely for companies whose customers are other businesses.

The invoice finance provider will usually look at your invoice book to assess whether you have a broad range of customers as this spreads the risk (it may work against you if you are too reliant on a sole customer). Your eligibility will also rely on the good relationship you have with your customers and their ability and willingness to pay on time. You will need to provide proof of this.

Young pensive undecided businessman in blue shirt and red tie looking up while leaning his chin on his hand. Searching for business solutions.

Can I use invoice factoring if I have bad credit?

Yes! What’s more, not only can you use invoice financing if you have less than perfect credit or are too new to have established a solid credit rating, but you can also use it for bad credit rehabilitation.

Even if you have been turned down for bank loan or other traditional lending options, you can be accepted by an invoice factoring company. The main reason for that is that they assess your customer’s creditworthiness rather than your business or personal credit history.

A benefit of invoice factoring for bad credit is that you can rebuild your credit (or establish it if you are a new business) using the cash flow that is made available through factoring your invoices. You can even use the funds to pay off existing debts and improve your credit standing.

What are the pros and cons of invoice factoring?

As with any type of business loans, there are pros and cons to using invoice factoring and you should always be sure you understand how it works.

Pros of invoice factoring

  •  Once set up then funds can be with you within 24 hours
  • It’s less time consuming than getting funds from the bank
  • Payments will be chased for you so you can get on with increasing your revenue
  • It helps you to avoid ‘awkward’ conversations with customers who are late with payments
  • It provides a level of administrative support so you don’t have to take on more staff
  • The factoring company can help you negotiate better terms with your suppliers
  • Free background and credit checks

Cons of invoice factoring

  • You allow the factoring company to take over your sales ledger
  • You’ll lose some of the provide that you make as you’ll be paying a fee
  • It may affect your ability to gain other funding
  • Your customers may think badly depending on how the factor financier deals with them

Is invoice factoring the right choice for my business?

If you want to unlock cash owed to you by clients without having to wait or chase up payments this could be the perfect funding solution for you.

Asking yourself a few simple questions will help you decide.

Do I want to access payments owed to me from raised invoices now?

Could I do without the hassle of chasing up payments?

Would I benefit from having extra support with bookkeeping and customer credit checks?

If the answer to these questions is a resounding yes then you might want to learn more about invoice factoring. If not, then invoice discounting might be more your thing! We compare over 30 lenders to find the best invoice factoring and discounting deals for businesses every day.

Featured Image Source: Helloquence