If you’re reading this then you probably have one question on your mind. What exactly is invoice factoring? The concept of factoring is simple and has been around for hundreds of years. Basically, companies sell their unpaid invoices to a factoring company at a discount, freeing up capital already earned for immediate use. Keep reading to learn more about this type of financial tool.
Who is Factoring Suitable For?
Invoice factoring is the selling of accounts receivable to a company, called a factoring company, specializing in this type of financing. For it to work for you, your business needs to have a substantial amount of accounts receivable. Most companies who choose to factor are business to business companies selling goods or services. Since most factor companies want to buy large batches of invoices at a time, your business needs to have enough owed invoices to meet these terms. Common industries that take advantage of accounts receivable financing are textile, transportation, advertisers, and media or any other business with large amounts of regular invoices.
What Are the Different Types of Factoring?
Factoring can be broken down into two types: recourse and non-recourse. Recourse, the most common type of invoice factoring, still holds the business owner responsible should their customer default on their statement or bill of sale. Non-recourse means the factoring company will assume any risk of the customer missing payment. Non-recourse agreements tend to come with bigger discounts and steeper fees but have that added layer of protection.
How Does the Discount Rate Work?
Factor companies charge a discount rate when they buy your invoices. First, they buy your unpaid statements at a discounted value and hold back a small percentage as insurance against any risk until that invoice is paid. They will usually advance around 85 percent and reserve 5 to 30 percent to be paid when your customer pays. The discount rate, which is usually 1 to 6 percent and can accrue monthly, weekly or even daily, is taken from this reserve amount.
Are There Any Other Fees?
Just like any other bank or lender, factor companies have their own additional charges and fees. These can be application fees, maintenance fees, cancelation fees or some other fee. Be certain to read all the terms and conditions associated with any factor agreement to get a clear picture of the total added expenses.
If your business is B2B, and you have enough accounts receivable, then factoring is a legitimate way to get faster access to money already owed to you and put it to work in whatever way your business needs.