When a business needs cash but doesn’t want to borrow money they can turn to Invoice Factoring. Rather than a bank loan, outstanding invoices are sold to a factoring company.
When your business delivers goods or services to a customer on terms an invoice is created. The average customer may wait 30 up to 120+ days before paying the invoice.
Rather than wait for payment, your business can receive an immediate advance on the face amount of the invoice from a factoring company.
The factor issues the advance and keeps back a portion in reserve. When the invoice is paid the reserve is released, less the factoring fee. There is no interest or loan fee charged as the process involves the assignment of an invoice rather than the creation of debt.
5 Steps to Factoring Invoices
Selling or factoring invoices is very straight forward with 5 main steps:
Step 1 – Invoice your customer for goods sold or services completed.
Step 2 – Submit the invoice to the Factoring Company or Factor.
Step 3 – Factor provides an immediate advance on approved customers.
Step 4 – Factor receives payment on the invoice directly from your customer.
Step 5 – Factor releases the reserve balance to your business less the factoring fee.
Accounts Receivable Factoring Example
Here is an example of how the numbers might work on a factoring transaction:
- $10,000,000 – Total Amount of Invoices Customers Owe to Business
- $ 9,000,000 – Advance Rate Paid to Business (Assumes 90%)
- $ 1,000,000 – Reserve Held by Factor (Assumes 10%)
Invoice Paid In 30 days
- <$250,000> – Fee Deducted from Reserve (Assumes 2.5%)
- $ 750,000 – Balance of Reserve Paid to Business
- $9,750,000 – Total Amount Received by Business
The amount of the advance, reserve, and factoring fee can vary by industry, customer strength, and how long it takes the customer to pay the invoice.
Some factoring companies might charge a small one-time set up fee to the business upon acceptance. Others will waive the set-up fee depending on the volume and length of the factoring contract. While the assumptions may vary from the example, they will always be clearly spelled out upfront in the proposal and agreement between your business and the factoring company.
How Factoring Helps
Factoring provides immediate access to cash so your business can pay bills, meet payroll, purchase inventory or equipment, manage overhead, fund expansion, and increase profits. Over the years many Fortune 500 companies have enhanced their growth using accounts receivable financing.
During the challenging economy many banks have declined business loans or lines of credit. Factoring provides an option even when banks say no since it is based on the credit worthiness of the customers paying the invoices. This means new companies may qualify and strong financials are not required.
These are just a few of the many advantages of selling invoices over increased debt. For more information please read the Benefits of Factoring and Frequently Asked Questions!
How to Get Started With Factoring
If you are interested in flexible cash flow solutions with accounts receivable factoring please contact us! We will discuss your objectives, answer any questions, and forward the factoring application. If you want to get a head start just download the Online Factoring Application!