Invoice factoring financing.
Invoice factoring is a financial facility that enables a business to sell its unpaid invoices to an independent third party (factor). It is also referred to as debt factoring. The factoring company then takes responsibility for collecting invoice payments. This alternative finance has become popular since it provides capital for a business that experiences longer payment terms with invoices.
It does not appear on the balance sheet as an expense, but rather a benefit without the traditional downside of a loan.
How it works
The business client submits details of the invoice to the factoring company, which will manage the credit control for a fixed period. Upon agreement, the factor will advance some funds to the client. The factor then proceeds with the collection of the debt from the customers. Once the invoice has been settled, the factor makes the remaining balance, minus their fee, available to the client.
Pros
- Invoice factoring provides businesses cash flow and immediate capital to compensate for funding gaps caused by slow customers. Compared to bank loans, which take months for approval to be determined, invoice factoring gives fast cash and keeps the business running.
- Businesses with imperfect credit systems utilize invoice factoring since it is more challenging to use traditional banks to get capital. Invoice factoring, in turn, offers easier approval from factoring companies whose primary concern is the value of the invoices
- Invoice factoring requires no collateral since it is unsecured. Hence, the lender cannot seize any assets upon failure to pay.
- Invoice factoring strengthens the business credit. Payments of taxes and suppliers are made quickly with cash in hand.
Cons
- Invoice factoring services are expensive. The business client should be one with a high-profit margin that will not be destabilized by the cost. Additional fees such as application and processing fees may also be included, and delayed payments can trigger an increment in your annual percentage rate
- The business client may lose an element of direct control. Invoice factoring, in essence, is handing over responsibility to a third party, which may collect invoices directly and could have access to information about the finances. It also opens up to a risk of data leakage.
- The relationship between the business client and its customers may Ibe jeopardized since a third party, who is not privy, is being involved. Proper communication and ethic must be observed in such agreements.
- Customers’ history of defaulting payment of debts may derail the business client’s financing. The creditworthiness of the customers may need to be verified and approved by the factoring company.