Businesses Can Unlock Cash Tied up in Sales Ledgers
Invoice factoring is a way for businesses to borrow money with minimal security because they are receiving an advance on invoices they have already issued.
Invoice factoring, also known as accounts receivable factoring, is a mechanism used by businesses to borrow money which is secured against the value of their outstanding debtors.
Many businesses sell products or services to other businesses and it is normal to give credit. That is, the business making the supply allows the organisation receiving the supply a period of time in which to make payment.
This means that at any point in time the firm offering credit will be owed a substantial amount of money. The number of days credit given will vary between industries and even organisations, but it is typically around 30 days, or one month.
So a business could be owned one month's income, which if it has a turnover of $1m means it could be owned over $80k.
Factoring allows an organisation to get hold of much of that money earlier than the 30 days by borrowing it from a third party, called a factor. This is a way of injecting additional working capital into the business which can be used to cover cash flow shortfalls or to invest in business growth.
The Benefits of Invoice Factoring
There are a number of reasons why a business would choose to use invoice factoring instead of another form of borrowing. These include:
* The amount borrowed can be up to 80% of the value of outstanding invoices, and sometimes higher.
* Little or no additional security is required because the loan is effectively secured on outstanding sales invoices.
* Credit control functions, such as raising statements and chasing for payment, can be outsourced to the factor, releasing resources for other tasks.
* The business can choose how much or how little it wants to borrow.
* The amount of money available to borrow will grow as turnover increases.
* There is reduced risk of the facility being withdrawn at short notice, unlike bank overdrafts.
How Invoice Factoring Works
Every invoice factoring agreement is different and there a variety of options that can be taken up. Here is an example of how a typical invoice factoring arrangement might work.
1. The business supplies goods or services to a customer and raises an invoice.
2. A copy of the invoice is sent to the factor.
3. The factor immediately makes a payment equal to around 80% of the total invoice value, sometimes more depending on the terms of the agreement.
4. The factor raises statements and pursues the customer for payment of the invoice in full.
5. When payment is received the factor pays the balance over to the business, less any charges.
It is possible for an organisation to choose confidential factoring, where their customers are not aware that factoring is taking place. This puts the responsibility for credit control on the business, rather than the factor.
When credit is in short supply the banks are less willing to lend to businesses, particularly smaller ones. Invoice factoring can be a valuable solution and can provide the capital that a business needs to fund further growth.