The definitions of the two terms “financing accounts receivables” and “factoring accounts receivables” are practically one in the same. The words “financing” and “factoring” are interchangeable when it comes to describing the process by which a business sells its invoices to a factoring company for cash.
The website Investopedia.com offers the following description of Invoice Financing: “A type of asset-financing arrangement in which a company uses its receivables – which is money owed by customers – as collateral in a financing agreement. A company receives an amount that is equal to a reduced value of the receivables pledged. The age of the receivables has a large effect on the amount a company will receive. The older the receivables, the less the company can expect. Also referred to as “factoring”.
Invoice financing, or invoice factoring, is a method whereby businesses of any size and within any industry can sell their accounts receivable invoices to factoring companies for cash. There is a common misconception that invoice factoring is only used by struggling or unsuccessful businesses as a last resort before they go out of business or contemplate bankruptcy. This could not be farther from the truth. Most businesses utilize invoice factoring in order to stabilize their cash flow. In other words, they use invoice factoring to speed up the customary three month payment period that is typical of many customers, who usually do not pay their outstanding invoices immediately. Businesses ranging from huge Fortune 500 companies to small start-ups have been known to use invoice factoring as a means of offsetting cash flow predicaments.
The most common myth associated with invoice factoring is that it is only used by failing businesses. However, failing businesses usually do not have a huge number of current outstanding invoices. Factoring companies are in the business of purchasing these invoices – – not lending money to failing companies. In fact, most businesses that sell their invoices to factoring companies turn around and use the cash they receive to facilitate additional sales – which results in more invoices that can be factored down the road.
In addition to the notion that only struggling companies take advantage of invoice financing, there are several other common myths associated with this service. Examples are as follows:
MYTH: A Business’s Customers will Become Upset When They Realize Their Invoices Have Been Sold to a Third Party (e.g. a factoring company) – Due to the fact that invoice factoring has become such a popular means of raising quick cash for businesses, most customers are neither surprised nor worried when their invoices are sold. In today’s economic world, most customers understand that businesses of all types and sizes utilize factoring as a means of expanding and growing and not as a last-ditch effort to survive. Because many successful businesses use invoice factoring as a preferred method of managing their cash flow, it is widely accepted and even endorsed by knowledgeable customers.
When invoices are sold to factoring companies, the factoring companies send a letter, called a “Notice of Assignment” to all of the business’s customers alerting them of the sale/transfer of their invoices. Typically, the letter will explain to the customers why their invoices were sold and will enumerate the benefits of the sale (e.g. to support the business’s rapid growth). In most scenarios, the only difference the customers will see is the address where they are instructed to remit their payments. In essence, the factoring company reassures customers and answers any questions or concerns they may have. However, in some situations, businesses prefer to deliver this information to their customers themselves – – and this is certainly something that factoring companies will honor.
MYTH: Factoring Companies are Like Collections Agencies and Will Harass Customers Who are Late in Paying their Invoices – It is important to establish that factoring companies are NOT collections agencies. But because they are the owners of the invoices they purchased from a business, it is their number one goal to collect every invoice that is unpaid. Even so, they do not operate in the same fashion as traditional collections agencies, which are notorious for aggressive and distressing practices. Factoring companies do remind customers of unpaid or late invoices, but they do so in a professional and courteous manner. Invoices that remain unpaid for an extended period of time are dealt with on an individual basis, which usually involves collaboration between the factoring companies, the businesses, and the customers.
MYTH: Using a Factoring Company Costs a Lot of Money and it’s Not Worthwhile – Invoice factoring is a unique business arrangement that is not the same as a business taking out a bank loan. It does not involve borrowing money at high interest rates. Factoring invoices is intended to help businesses make more money. By receiving cash quickly for selling their invoices, a business has opportunities to use the available cash to grow and thus to thrive. Therefore, the cost of factoring invoices becomes almost moot because factoring is simply being used as a tool to launch a business forward. Another reason invoice factoring makes sense and is a worthwhile expense is that it alleviates the need for a business to employ an entire staff for the sole purpose to accounts receivable. The savings on salaries alone may make up for the entire cost of invoice factoring. With invoice factoring, the business usually pays a nominal percentage of the total invoices being sold to the factoring company – but this is usually equal to a very small cut.
MYTH: Factoring Companies Only Understand How Certain/Common Types of Businesses Function – The concept of invoice factoring has been in existence for many decades. Because it has become one of the most commonly and widely accepted methods for a business to quickly raise cash, invoice factoring companies have expanded to work with businesses involved in just about every industry. Invoice factoring companies are aware that every business is unique, and they work to fully understand each and every business with which they work. Businesses should not necessarily avoid invoice factoring simply because they think they are unique or have seemingly complicated operation practices. Most invoice factoring companies have dealt with extremely complex situations and are experienced in handling even the most unusual scenarios. Ultimately, a business involved in any type of product or service industry that bills customers using invoices is a candidates for invoice factoring.
Editor’s Note: Greg Curtiss is President of The Invoice Bankers. Mr. Curtiss previously was a lawyer and has passed the CPA exam. He has been in business for over 25 years. You can reach him by calling 303-740-7600 or 1-888-740-1750.