Invoice Factoring refers to a financial tool utilized by businesses that do a lot of B2G or B2B invoicing. This financial tool offers working capital in the short-term in exchange for assigning and selling invoices to a factor. The factor offers you 80 percent of the value of the invoices in advance. After payment of the invoice, the factor pays the 20 percent balance after subtracting fees.
Invoice financing and invoice factoring are two different terms that are used interchangeably at times. Although similar, invoice financing is easier to use, requires no invoice assignment, and is more streamlined. Additionally, invoicing financing companies such as Fundbox, work with B2C invoices.
Invoice factoring is usually used to solve cash flow problems in the short-term. It is often used as a way for companies to simplify the conversion of invoices to cash. However, it is not a financing type used for large capital investments.
The process works whereby the invoices that are due within three months are sold to a factor. The cash is quick and immediate. The five steps to invoice factoring include:
1. Invoicing a Client
After offering services or products to your B2G or B2B customer, you issue them with an invoice for payment of goods or services provided. For these invoices to be legible for factoring, they have to be payable within three months.
2. Selling and Assigning the Invoice to a Factor
To get a factor, you need to work with, undergo the process of application, and sell all your outstanding invoices to them. After submission of the invoices, the factor will see if you qualify for financing. They will also carry out due diligence on the customers that have been invoiced to determine their credit risks. After you qualify these criteria, your business will be approved, and you will sign a financing agreement along with the factor. The agreement will state a ceiling for the maximum amount that can be borrowed, which is the maximum amount of invoices to be factored.
3. Payment of Advance
You will receive an advance rate, an initial advance, from the factor. The advance rate is usually about 80 percent of the factored invoice value. The advance amount is reliant on the transaction size, the industry, and other risk parameters as well. At this stage, the factor sends a “notice of assignment” to the customers under the factoring agreement. You could also send it depending on the agreement with the factor. The notice of assignment explains that your organization has assigned the factor as the company to receive future funds regarding the invoices you issued them. All the funds will go to a lockbox account, which is an account for receiving the payments of the factored invoices and is set by the factor.
Some industries are more used to invoice factories than others. Shipping and trucking firms regularly use freight factoring, while recruiting agencies and staffing firms utilize staffing factoring. Industries that are used to invoice factoring do not usually face issues with clients being factored. But industries not used to invoice factoring could be more suited for invoice financing, which needs no assignment of invoices.
4. Payment to the Factor
The factor will be paid by your clients within three months according to the invoice terms. The factor will usually take care of the collection of all the invoices assigned to them. Normally, the factor will attempt following your history regarding the techniques of collection, unless it’s late. This means that your customers will not be affected negatively.
5. Payment of the Balance
After getting the payment from your customers, the factor will provide you with the balance of the invoice, referred to as the reserve amount, after subtracting the fees.
Invoice factoring is ideal for businesses that require a consistent solution for their cash flow issues. It is also perfect for companies that invoice at least $25,000 per month to B2G or B2B customers. Choosing this form of financing means you bring an extra partner in your business to manage and collect the accounts receivables. This includes being willing to offer control of your customers to the factor who will be handling them.