Invoice factoring is a kind of invoice financing in which you "sell" a percentage or all of your organization's unpaid invoices to a third party to improve cash flow and revenue stability. So, a factoring business will pay you most of the billed amount immediately and then collect payment from your clients directly. Invoice factoring has advantages and cons, which we will discuss in this post. Invoice factoring is also known as Receivable Factoring or Debt Factoring. We recommend the online tool called Invoice Builder.
How does Factoring work?
Invoice Factoring is the sale of control over your accounts receivable, in part or whole. It operates as follows:
You usually supply items or services to your consumers.
You bill your consumers for the items or services you provide.
The raised bills are "sold" to a Factoring business. After verifying that the invoices are authentic, the factoring business immediately pays you most of the billed amount, often up to 80-90% of the value.
Your customers make direct payments to the Factoring firm. If required, the Factoring business pursues invoice payment.
When the invoice is paid in whole, the Factoring firm pays you the remaining invoice amount minus their charge.
When should your company use Invoice Factoring?
Invoice factoring should be used when your firm frequently has many unpaid invoices and your cash flow suffers.
Assume your company sells on a 30-day payment schedule. Most of your creditors will pay within 30 days – some may require pursuing, others may not – while some may exceed the limit and necessitate more persistent effort on your behalf. That30-day income chunk may represent most of your future cash flow, but you can't utilize it. Invoice factoring enables you to unleash that cash, or at least a portion of it, instantly. You might put your money towards:
● Short-term costs must be bridged.
● Pay back a loan
● Profit from seasonal business prospects.
● Or for any other reason where cash flow can be a constraint.
Advantages of invoice Factoring
Improved and more predictable cash flow
You may get most of your bills paid nearly instantly by employing invoice factoring instead of waiting for the capital to come in (potentially after extensive chasing on your behalf). It improves company planning and forecasting and helps you to capitalize on opportunities that might otherwise be out of reach.
Better chance of your business surviving
Better cash flow increases your company's chances of survival. Many businesses fail due to insufficient cash flow, and invoice factoring may help you keep yours healthy if you utilize it appropriately.
Disadvantages of Factoring
Unsuitable for businesses with few customers
Invoice factoring is not appropriate for businesses with only a few key clients. Companies that factor seek to spread their risk as broadly as possible. They strive to avoid sending many bills to a small number of consumers.
Requires a big commitment
Although it is sometimes feasible to factor in a limited number of invoices (this is known as selective or spot Factoring), most Factoring businesses will want to take over most of your accounts receivable. They may also try to sign and lock you into a long-term contract of two years or more. This is vital from their standpoint, but it means you won't be able to dip in and out of invoice factoring at any moment. It's a significant business choice.