Every business, even profitable ones, encounter different hurdles before attaining the sweet peak of success. Some stores may run into customer relations problems. Some may experience intense business competition. But most ventures, one way or another, will come up against financial and funding struggles along their business journey and there is also factoring.
Whether it is for capital or cash flow reasons, money plays a significant role in every business. For small-sized enterprises, maintaining a working capital can be quite a challenge. As your business grows, your payroll, operating cost, and supplier expenses grow as well.
For financial problems, the go-to solution of most firms is bank loans. However, if you want an easy and fast funding solution that does not involve loans and interest rates, then factoring is for you.
Factoring: Definition and Basics
One of the oldest forms of financing, factoring, is an immediate cash solution done by selling your credit-worthy invoices to a third party (called factor or factoring company). Factors can be banks, large enterprises, or individual factoring companies. Most businesses that opt for a financing solution like above are those in the trucking, clothing, and manufacturing industries. Factoring is also known as debt factoring, asset-based lending, and invoice finance.
How Does Factoring Work?
Invoice finance pertains to the process of selling your company’s accounts receivables to a factoring company. Accounts receivable are money owed to your company by customers.
At a small discount, factors will then purchase those invoices from your company along with the right to collect payments on the said invoices. They will then give you a cash advance of about 75% to 80% of your invoice’s total face value. The remaining percentage will be paid once your customers pay their debts to the factor.
Invoice financing can go in two ways:
- The factor has control. This usual setup makes the lender have total control in collecting due receivables. Upon payment completion, the lender will then deliver it to the borrower, minimizing the risk of non-payment to the lender’s side.
- The borrower has control. The borrower retains total control over the payment collection from customers. The accounts receivable only serves as collateral to the lender’s cash advance.
Factoring is an immediate, short-term funding solution to help businesses clear cash flow hurdles. Factors do not look at your credit score; they choose companies with creditworthy customers, even if they are not eligible for bank loans.
Invoice financing service fees range from two to three per cent, depending on your credit quality and financing volume. Payments may also be a monthly, quarterly, or a per 10-day basis, depending on both parties’ agreement.
What Are The Advantages of Factoring?
Lacking capital to fund your day-to-day operations poses a danger, especially for small to medium-sized businesses; invoice financing will undoubtedly help smooth out cash flow management issues immediately.
Its primary purpose is to unlock tied funds and let firms take on new clients without waiting for slow-paying customers’ payment. Most factoring companies also help in handling credit collections and improve existing credit terms with your customers. This setup improves your sales and will save you a lot of admin time.
Invoice financing is not only for SMBs with strained cash flow. It is also for:
- Companies with unpredictable payors
- Companies that want to meet the target product demand
- Enterprise who want to expand and;
- Firms who want to accommodate multiple big clients and opportunities.
Not every venture is fit to consider factoring as an immediate cash flow solution. You should consider some factors beforehand, such as the frequency of your company’s receivables and the purpose of your financing needs. Asset-based lending provides a quick source of healthy cash flow, but it will only be a band-aid solution for those with a substantial cash-flow gap. Annette&Co. can help you with this matter, request an appointment today. Our YouTube channel is also available for subscribers, as are all of our social media channels.