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Invoice factoring, sometimes referred to as “accounts receivable financing” or “invoice discounting”, is a commonly used method of financing that entails the selling of accounts receivable, or invoices, by your business to a finance organization in exchange for immediate cash. The financial organization, also known as a “factoring company” or “factor”, provides your business with an initial payment, or “advance”, which typically ranges anywhere from 80-95% of the gross invoice value. This advance is usually provided within 24 hours of invoicing, by the factor, who then waits to collect payment on the invoice from the customer. As soon as they receive payment in full, the reserve balance, minus a small fee, is refunded to your business. In the simplest terms, for a small fee, your business can sell its invoices immediately instead of waiting to collect from your customers.
Yes, there are two primary flavors: recourse and non-recourse. Recourse means that the business takes responsibility for the ultimate payment of the invoice. With non-recourse, the factor assumes the credit risks relating to collection of the invoice. Since recourse is inherently less risky for the factor, it is almost always the cheaper option for businesses. While these are the two primary types, fee structures and contract terms will vary by funding source. As a result, it’s important to work with a specialist that offers the best fee structure and contract terms for your unique needs.
It can be the perfect cash flow solution for any business that is looking to quickly convert their receivables into cash. More specifically, accounts receivable financing can be utilized by a business of any size, in any industry, where the business provides services or goods to another company and receives payment on terms. These terms may vary from seven days to upwards of 90 days, with the average payment term for most transactions falling between 30 and 90 days. If you’re unsure whether your business qualifies for invoice discounting, contact us today and we’ll help you determine if it’s the right cash flow solution for your organization.
How about a quick numerical example using a 95% advance rate and 1% fee? Assuming that Acme Manufacturing just fulfilled a $50,000 order from Customer & Associates, Acme first generates a $50,000 bill which it sends to Customer and the factor. The factor quickly verifies with Customer & Associates that the work was completed and that Customer will pay the invoice in full. Once verification is completed, typically within 24 hours or less, the factor then advances Acme Manufacturing $47,500 (95% of gross invoice value) and waits for Customer & Associates to pay the invoice in full. As soon as the factor receives the $50,000 payment from Customer, it deducts the fee of 1% ($500 in this example) and releases the remaining 4% reserve, or $2,000, back to Acme Manufacturing. During the 30, 60, or even 90 days that the finance organization is awaiting payment from Customer, Acme has unrestricted use of the $47,500 that it initially received to meet payroll, cover operating expenses, fulfill even larger orders, or use for just about anything it deems necessary.
While fees will vary by funding company, they typically range anywhere from 1%-5% of the invoice amount. Although fee rates differ across companies, there are a few basic items that nearly all invoice factoring companies take into consideration when determining pricing: industry, monthly volume, customer concentration and credit worthiness, average invoice amount, and average customer collection period. Furthermore, fees are highly correlated with advance rates, meaning the higher the advance rate, the larger the fee will typically be.
There are several reasons why your business might choose to sell its receivables. To begin with, it entails the actual purchase of your accounts receivables, and as such, it is not a loan and is therefore not reflected on the balance sheet as debt. As a result, your business is free to use the proceeds however it sees fit since there are no covenants, restrictions, draw fees, or other stringent requirements that are commonly associated with commercial loans.
Many businesses find it diffficult to grow as accepting more and larger job requests is almost always accompanied by an increase in upfront expenses and a delay in payment collection. By selling your receivables, your business will be able to grow without these worries as invoice discounting allows you to monetize your invoices almost immediately, usually within 24 hours or less.
Furthermore, it also relieves your business of the burdensome collections process since the factor takes care of this time consuming activity. Receiving customer payments within a timely manner is in everyone’s best interest, that’s why the factor handles the back office work which allows your business to focus on growth and productivity.
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