Invoice Factoring

Factoring is a service that allows a company to sell their accounts receivable (invoice payments owed to their business) to a finance company, usually a bank.

A key advantage of this type of invoice financing is that your company can save money because they do not have to employ an accounts person, or department, to perform the credit control functions of the company. However, the main benefit is that it helps companies streamline their cash flow, something that can provide companies with a lifeline in these hard financial times.

Cash flow problems are encountered at some time or another by the majority of companies in the U.S, even if they are in profit. One effective, but bleak, analogy for this problem is that lack of profits is like a long term illness that affects your company over time but being hit with cash flow problems is like a heart attack, it stops you in your tracks. You would not have the funds to pay your bills and then could face supply problems, which in turn would affect your customer base.

Factoring helps with cash flow in the following way; the company (known as the client) sells their invoices to a financial institution (known as the factor). The factor then makes a cash advance to the client, which is usually 70-85% of the total invoice amount. So, instead of the client having to wait at least 30 days (and sometimes a lot longer) to receive payment, it is available almost immediately.

Other benefits are that you would have more cash available to you than if you went for an overdraft or a loan, because the payments are based on the amounts you actually invoice, rather than restricted to a lump sum. Every time a new invoice is raised, the money can be obtained from the factor so it is an ongoing process that allows you to grow your business. Growth can be enhanced further because, as your cash flow is now predictable, you can plan more effectively and keep your balance sheet healthier.

The remaining invoice amounts owed to the client are paid when they have been settled by the factor, minus their commission payment (commission payments are usually a percentage of the invoice amount and can vary between factoring companies). The factor makes sure that the invoices are paid in full into their bank account from the company that has been invoiced (the debtor). This service is what saves you from having to employ a credit controller.

Many factors also offer additional services such as bad debt protection which determines who ‘owns’ the financial risk involved if the debtor fails to pay an invoice owed to the client. There are 2 different types; recourse and non-recourse factoring (or factoring where the risk still lies with the client and factoring where the debtor takes on the risk). The ‘owner’ of the financial risk will suffer the financial loss should the debtor fail to pay an invoice.

As you can see, the factor taking on this kind of risk has notable benefits for the company and may even add an enhanced sense of financial security. However, bear in mind that higher commission fees are charged for this type of factoring, so the higher commission charge needs to be weighed up against the possibility of a debtor failing to pay their invoice.

As you can see from the information above, choosing the right factoring company for your business is a very important decision. Contracts and small print need to be analyzed in detail because some factoring companies have up to a 3 month notice period for early termination before the end of the contract period, there may also be a penalty to pay if you wish to prematurely cancel your agreement. There are also other ways that financial penalties can be accrued if the exact terms on the invoice factoring agreement are not adhered to, but these can vary between providers.

Using a factoring comparison website such as TrackCompare.com helps making this key financial decision easier for you.