Factoring is a financing tool that allows you to get your invoices paid in as little as 2 days. It provides your company with the necessary capital to operate the business, pay suppliers and grow. However, factoring is not a business loan. Rather, factoring involves selling your invoices at a discount for immediate cash. The factoring company waits to get paid, while you get immediate use of the funds.
Invoice factoring can easily be integrated to any business and works as follows:
- You deliver goods or services and invoice for them
- You sell the invoice to the factor. They give you the first installment of 70% to 90% of your invoice. This is called the advance.
- You get immediate funds to run your business
- Once the customer pays the factoring company, you get the second installment (of 10% to 30%) and are charged a small fee for the transaction. This is called the rebate
Although receivable factoring costs vary and are based on transaction size and timing, the average cost of a transaction is usually between 1.5% to 3% of the invoice per month.
One major advantage of factoring is that it is easier to obtain than a business loan. Furthermore, the the factoring company can be set the financing line in about a week, and the biggest requirement for approval is that do you business with credit worthy clients.
But invoice factoring is different from most traditional business financing. For starters, it is not a loan, but rather, a sale of invoices. Although it may not be clear at first sight, you can finance your business by selling your invoices.
Basically, when you factor your invoices, you sell them to a factoring company, who pays you for them. When the factor buys your invoices, it’s common that they’ll pay you in two installments. The first installment, called the advance, is provided as soon as you sell the invoice. The second installment, called the rebate, is provided once your client pays for the goods/services.
Lets look at a receivable factoring transaction to see how it works
- You deliver goods and services to the customer.
- You invoice the client
- You sell the invoice to the receivable factoring company
- Factoring company advances (installment #1) between 70% and 95% of the invoice
- You get immediate money for your business
- The customer pays the factoring company
- The factoring company rebates you (installment #2) the remaining money, less a small fee
As you can see, factoring receivables provides you with accelerated funds that can be used to run and grow the business. Although accounts receivable factoring is a great tool, it only works to solve one very specific problem. That is, that you can’t afford to wait to get paid by your clients. However, it solves this problem better that most other financial tools. Furthermore, as opposed to bank financing, invoice factoring is easy to obtain and can usually be set up in days.
Every day many business owners hit a wall. That wall prevents them from growing their business, or at least, severely limits the speed at which they can grow their companies. Sometimes, and especially for small and mid size businesses, the wall appears to be insurmountable. That wall is lack of working capital. Let’s take a look at the most common source of working capital problems: extending payment terms to customers.
There are few things that small business owners hate to hear more than a customer utter the words, “We’ll be happy to do business with you. However we pay net 45 days”. As is well known, commercial clients like to pay their invoices in 30 to 45 days. As a business owner, you are expected to go through the trouble and expense of delivering your product or service on time… only to then wait 30 to 60 days to get paid.
Businesses that hit the wall have a great asset that can be turned into immediate funds. They just don’t know it. This asset is their unpaid invoices from credit worthy clients. Let me give you an example. Let’s say that you have a $10,000 invoice from General Electric payable in 45 days. Do you think GE will pay? Isn’t that invoice almost as good as money? Well, of course. GE is arguably one of the best and most financially stable companies on the planet. Most people would certainly consider that invoice to be “almost cash”. Unfortunately, banks will seldom provide you any financing that relies on that “almost cash”. However, there is a solution that relies solely on the power of your unpaid invoices. It is called factoring.
Invoice factoring allows you to turn your slow paying invoices from good customers into immediate cash. It’s a very simple transaction in which you trade an invoice – “almost cash” – for actual cash. Basically, the factoring company provides financing solely on the power of your soon to be paid invoices.
Provided that you have good customers, you can repeat this process for every invoice you have, almost indefinitely. If you sell products to good credit worthy customers, a factoring company will gladly buy your invoices. There are no limits, except how much you can sell.
One important thing to know about factoring is that it doesn’t generate debt. The factor does not loan you money for your invoices. It buys them outright from you at a small discount. Since factoring is not a loan, qualifying for it is easy and your financial statements look cleaner. You just need a well-run business and great customers.
Most business owners try to address this issue by going to a bank to try and get a business loan. However, banks are notoriously conservative and getting a business loan can be very difficult. This is where a factoring company can help you.
Factoring companies eliminate the 60 day wait and get your invoices paid in as little as 2 days. How? By buying your invoices and paying you immediately for them. You get the business financing you need, while the factoring company waits to get paid by your client. You get money to meet immediate expenses such as payroll, rent and supplier payments.
One of the big advantages of working with an invoice factoring company is that they can usually extend you more financing than a bank can. Whereas a bank will set a credit limit based on your company’s financial situation, the receivables factoring company will set a limit based on your sales potential. This allows you to grow your company to its true potential.