January 11, 2022

Invoice Factoring Can Ease Your Cash Flow and Streamline Accounting

Written by
Susan Ranford

A recommended tip by consultant firm McKinsey is that firms must “cast a wider net for new efficiency opportunities,” going beyond mere transactional activities. 

This tip is a timely reminder for business owners with different financial stress points, including business owners who wait for clients to pay their outstanding invoices while the creditor calls hourly.

If you are experiencing this stress, it’s time to consider another finance management strategy to ease cash flow. We recommend that you use invoice factoring to alleviate your financial stress. Read on to find out what it’s all about.

Why use Invoice factoring?

Most business collections are set to credit terms of 30 to 90 days, meaning that an invoice is posted to your customer at the point of transaction. The actual cash will only flow in at least a month or longer.  

You’re unlikely to be able to utilize that money for this period. The unaccountable cycle puts many small business owners in a constant cash crunch, making it hard to keep up with monthly expenses like payroll, utilities, or inventory. That prevents the business from investing in growth opportunities or maintaining day-to-day operations that keep everything on track.

Therefore, we recommend trying invoice factoring to ease the cash crunch. 

What is invoice factoring?

Invoice factoring is a financial product in which you sell your accounts receivable to a third-party factoring company in exchange for cash upfront.

Bank Business loans require complete applications where the bank qualifies your special status. This process takes some time. However, invoice factoring allows a factoring company to give you cash upfront in place of client payments. 

 Here are three parties involved in the transaction:

  • The Seller (Business Owner)
  • The Debtor (Business Debtor)The Factoring  (The factoring company or bank)

This is how the loops work.

  1. The Seller completes a service or delivers a product, then sends an invoice to the Debtor.
  2. The Seller submits another copy of that invoice with delivery order to the Factoring Company for funding (for example, on Day 1).
  3. The Factoring Company advances between 80-90% ( as agreed between the seller and Factoring company) of the invoice value to the Seller, deposited into their business bank account.
  4. The Debtor credit payment to the Factoring Company, which goes into a lockbox in the Seller’s name (for example, on Day 25).
  5. The remaining 10-20% less factoring fee of the invoice value is released to the Seller, for example, on Day 26).

What is a factoring company? 

A factoring company provides invoice factoring services. This company can also be a bank that allows you to apply for a factoring account. The factoring company buys a business’s unpaid invoices at a discount.  

Once your client pays their invoice to the factoring company, you’ll get the rest of the money due to your business minus the factoring company’s fees.

This step allows small businesses to unlock the cash value of their invoices before they receive payment from customers. So the application is very straightforward.

Should you factor with a bank?

Invoice factoring is the same process. However, there are some differences whether you choose to work with a bank or a factoring company. Let’s take a look at them:

Independent factoring company

Independent factoring companies usually are for businesses that need to accelerate cash flow and may have been rejected by a bank.

However, an independent factoring company must borrow from a third party to fund your invoices. That can be risky as it increases costs for your business, reducing efficiency.

Bank factoring company

A bank factor provides the same flexibility and benefits as an independent factor and offers additional advantages.

  • Easier transition to a bank loan , A bank factor works with many businesses that are considered outside the traditional credit box. Many of these businesses have been told “no” by a bank for a commercial loan, but they are still candidates for working with a bank that offers factor or accounts receivable financing. Businesses that work with a bank-owned factoring company may also have a better portfolio transitioning to a commercial loan at a later date.
  • Greater security , Banks are more secure and provide a sense of financial stability. A bank offers a level of trust not found in independent alternative financing companies. Clients may feel better about interacting with a bank than an unfamiliar or unknown business entity.
  • Competitive rates , In addition, since the bank has its funds, it can offer excellent business rates. Unlike many independent factoring companies with multiple funding sources, a bank is a direct source of funds and eliminates the broker.

Cash flow is the lifeblood of a business, and it can determine if the business grows. If you’re considering invoice factoring, it probably means you’re looking for a quick and reliable source of funding. Factoring can do just that: quickly turning your receivables into cash.

Factoring Application

The factoring company requires all these documents to qualify the business owner for a factoring account.

  • A factoring application
  • An accounts receivable aging report
  • A copy of your Articles of Incorporation
  • Invoices to factor
  • Credit-worthy clients
  • A business bank account
  • A tax ID number
  • A form of personal identification

Gather these documents and ensure they’re up to date before seeking out a factoring company for the easiest application and onboarding process.

Final considerations for invoice factoring 

Like any financial tool, there are always risk factors entailed. Business owners must do their homework before considering invoice factoring. Here are the elements they should consider.

  1. Factoring can be a significant cash flow solution for all businesses and stages of growth. For example, many large construction companies employ factoring simply to reduce debt. The main contractor will delay their payment until the developer has semi-completed the project. The subcontractor needs factoring to keep their business afloat.
  2. While factoring is more expensive than traditional loans, most companies factor into their prices to compensate for factoring costs.
  3. Invoice factoring is often most suitable for businesses with poor credit. That’s because factoring companies only care about the creditworthiness of your customers (because they’re the ones paying the invoices), not you as a business.
  4.  Every factoring company is different. Some will hide fees, float, and other added costs that make factoring unsustainably expensive and unpredictable. Find a reliable company that is 100% upfront with their fees.

Conclusion:

Invoice factoring can reduce the stress of funding for small business owners. With that out of the way, they can focus on more value-added transactions to grow their business in the direction they want, rather than worrying about inflows and outflows.

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