Cash flow problems are not uncommon especially to businesses that deal in large supplies to customers. Slow paying customers or immediate cash demands can easily result in a cash squeeze which if unresolved, quickly affects the company’s operations. To meet their cash flow needs without resorting to debts and dipping into their savings, companies with such a problem can now use invoice factoring.
What is invoice factoring?
Invoice factoring, also known as payroll factoring refers to a cash flow solution where a firm with outstanding invoices that have long net terms say 30-120 days, transfer these invoices or accounts to a third party called a factoring company. In return, the factoring company advances to the firm much of the invoice cost– usually between seventy to ninety percent. The factor has to check on the creditworthiness of the customers billed in the invoice before advancing the money.
Once the customer makes payment, then the factoring company remits the balance of the invoice after deducting its fee for the transaction of factoring service. For a company that was suffering from cash flow issues, payroll factoring allows them to meet their employee needs and maintain workplace motivation while also avoiding debt.
There are several benefits provided by invoice factoring. These include:
- It takes a short period compared to alternatives. If a company chooses to wait for the customers to pay up, it may take 30 or more days. Loans from banks and other financiers also attract extended processing periods, and they may not offer a substantial amount as it may be needed.
- The creditworthiness of the company is not considered. Businesses which are just starting or which do not have strong credit ratings may find it hard meeting their emergency cash flow needs through banks and related institutions. On the other hand, factoring companies only consider the ability and credit score of the business’ clients which makes it easy to earn financing.
- The factoring company is the one in charge of collecting the payment from the invoiced companies. This arrangement means the company that made the supplies does not have to involve itself in following up after debts and therefore there is no need to staff the function or hire external services.
- Factoring companies also help businesses seeking to expand overseas since they have better connections with suppliers and purchasers globally.
- Startups can significantly benefit from factoring their invoices since they may have received orders but lack the credit rating to earn loans or get financing without giving part of their business. Since they still have to run invoice factoring, companies give them the money at a fee.
The downside to financing is that it can be costly compared to conventional financing options. Businesses with many but low-value invoices may also not find it economical due to the fee charged per invoice. However, its convenience in terms of speed and less paperwork means it is still a preferable alternative.