How is Invoice Factoring Used?
In the most basic terms, invoice factoring is the process of selling accounts receivable invoices to an invoice factoring company for cash. Factoring serves a few purposes for businesses in need of cash flow. First, it allows businesses to outsource their accounts receivables to factoring companies. This alleviates the need for businesses to employ a large accounts receivables staff. Second, invoice factoring allows businesses to have immediate access to money owed on outstanding accounts receivables without having to wait 30, 60, or even 90 days for invoices to be paid by their customers. And third, invoice factoring does not require businesses to take out costly bank loans that may charge high interest rates.
Invoice factoring differs from bank loans and other types of financing in several ways. One of the most important differences is that factoring is a means whereby businesses can raise cash very quickly – often within a day or two of selling their invoices. Another difference is that invoice factoring, unlike a bank loan, is not based on the credit ranking of the businesses that wish to work with factoring companies. Instead, factoring companies look at the creditworthiness of a business’s customers. In other words, factoring companies evaluate how likely it is that these customers will pay their invoices on time – – not whether the businesses themselves pay their own bills in a timely manner. There are several other differences between loans and invoice factoring. For example, invoice factoring companies provide assistance with collections efforts on unpaid invoices, whereas a bank loan is simply a loan that must be repaid in monthly installments.
The Following are Some of the Most Common Reasons Businesses Use and Benefit from Invoice Factoring:
- Rapidly Growing Businesses Can Quickly Receive the Cash they Need to Expand. When businesses are poised to grow very quickly, they often experience cash flow problems due to unpaid invoices. This can create real problems for businesses because instead of focusing on continued growth and success, they must expend resources attempting to collect invoices that remain unpaid. Businesses stuck in this type of scenario are not able to move forward because they are waiting for customers to pay their bills. But when the outstanding invoices are sold to factoring companies, businesses obtain the cash they need to advance while the factoring companies spend time and resources to collect unpaid invoices.
- It Can Be Difficult for New Businesses to Find Bank Financing. In many cases, banks will not offer credit or financing to new or start-up businesses that have not been operational for at least a year or two. Without an established and good financial history or a proven track record of successful business practices, many young businesses are denied financial assistance from banks. Therefore, such businesses often turn to invoice factoring as an excellent means of raising cash quickly to solve cash flow problems. In the end, using invoice factoring instead of obtaining bank loans means businesses that are still in their infancy do not have to take on as much debt.
- Seasonal Businesses Can Have Challenges Obtaining Bank Loans. Banks are often adverse to loaning money to businesses that are only operational during certain months of the year. Loans are usually offered to businesses that can show a positive cash flow consistently month after month, and loans are usually not extended when businesses do the bulk of their business during particular seasons. In other words, banks want insurance they will receive loan payments each and every month. Thus, with bank loans practically unavailable to them, seasonal businesses often opt for invoice factoring so they receive cash upfront for invoices that will be paid later.
- Businesses Are Able to Obtain Cash When They Need it Most. When businesses are short on cash, they can face serious operational problems. Not only can a shortage of cash mean not enough money to pay taxes, salaries, and other bills, but a shortage of cash can mean thriving businesses cannot produce the products or services that are in demand by their customers. This can be detrimental for businesses and can even cause them to fail entirely. When cash is needed and there are outstanding invoices, businesses utilize invoice factoring to solve their cash flow problems. In most cases, businesses qualify to work with invoice factoring companies because factoring companies evaluate the credit worthiness of their customers, not the financial history of the businesses themselves.
- Specific Invoices Can be Selected for Factoring. Businesses may not want to factor all of their invoices, and that is perfectly acceptable. With invoice factoring, businesses can pick and choose which invoices they want to sell. In most scenarios businesses will sell a batch of invoices to invoice factoring companies, and not single or individual invoices. But the details of the agreements between businesses and invoice factoring companies are unique to each situation. Also, some invoice factoring companies have different requirements than others.
- Businesses Can Focus Their Attention on Operations Instead of Collections. One of the most compelling reasons businesses sell their invoices to invoice factoring companies is that it eases the need to focus their efforts on collecting unpaid invoices and allows them to concentrate on running and growing their profits. Selling outstanding invoices to factoring companies relieves stress on businesses that don’t have the manpower to give attention to accounts receivable collections.
- Invoice Factoring Can be Used to Survive Unexpected Situations. Even though it is an unpleasant thought, sometimes situations can arise that put businesses in financial jeopardy. For example, an unanticipated departure or death of a critical employee can cause businesses to halt some of their operations. Natural or other types of disasters can also be detrimental to businesses. In such instances, businesses commonly seek assistance from invoice factoring companies on a one-time basis to help them through a difficult period. Factoring companies are excellent financial resources for businesses suffering from unusual or uncommon situations.
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.