Business Advice: An Introduction to Invoice Factoring

Small and medium-size business owners and managers have a number of major goals. Two important ones are to:

  • Reduce overhead costs
  • Increase cash flow

In this article, we will discuss the idea of invoice factoring. It is only one option, and one that may be worth exploring in your particular situation. Factoring sales invoices is the equivalent of accepting credit cards. By taking credit card payments, business owners know they will be paid within a few days in exchange for a small discount. Many small businesses wait a minimum of 30 days to get paid by their customers, and others wait even longer. Invoice factoring guarantees almost immediate payment, and can remove the need to chase slow payers. This enables, you, the business owner or manager to, for example, focus on growth planning, customer care, and keeping working capital at the appropriate level.

How Does Invoice Factoring Work?

A business sells its future sales revenue, at a small discount in exchange for immediate payment. The business should serve commercial or government customers, and those customers should have good credit. The factoring company will take on the responsibility of collecting the invoice payment, so they must minimize their own risk of defaults.  Your invoices must be free of encumbrances, such as the bank as part of the overdraft facility agreement.

Your own profit margins should be above a minimum level, since the factoring company must be confident you will stay in business. They will also run a simple background check on senior personnel.

Some Benefits of Invoice Factoring

It improves cash flow. Your customers may, typically, pay in 30 to 90 days. Factoring puts cash in your bank account, quickly, and customer payment lead times cease to be your responsibility.

Many small and medium-sized business operate with an overdraft or loan facility. Factoring is usually easier, quicker and less costly than arranging bank finance. The reason, simply, is that the business is not applying for a loan, but simply selling unpaid sales invoices for a discounted cash amount.

Factoring is a flexible facility, so the business is not required to sign a long-term factoring agreement or to make a fixed commitment. The business can increase or decrease the number of invoices that are factored out. Working capital needs may vary, so it is common to vary which invoices from which customers the business holds for payment in the traditional way, and which are factored. Factoring, therefore, becomes responsive to changing needs, and it removes the need to renegotiate bank credit limits or loan amounts.

Factoring normally has two methods of operating; recourse and non-recourse. Non-recourse agreements, mean that the factoring company becomes responsible for bad debt recovery, not you, which is one reason factors expect credit-worthy clients, and that those clients’ customers are also credit-worthy.

The Take-Away

You are in business to make money. You market, manufacture or produce, and sell. Your goals include selling more products and services to more customers, and to keep operating and overhead costs to a sensible minimum. Factoring sales invoices can remove a lot of “non-productive” and time-consuming activities, leaving you free to focus on your core business activities. Is factoring right for your business? That decision is one to make after appropriate analysis. This article is a simple introduction to the topic.

Remember, running a business successfully does not need to be complicated.  Keep it simple!

For more information on business analysis, business planning, and ways to grow your small business profitably, please check out our website www.portalcfo.com.

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