Invoice factoring is a type of business finance that is used to improve cash flow and to decrease the probability of bad debt. Invoices payable which are owed to the business are sold to a third party, an invoice financier which may be an independent factoring house, part of a banking institution or other financial group. The company using this invoice factoring service benefits by receiving payments earlier.
In effect, the invoice financier buys the debt owed to the company by its customers. Usually, the invoice factoring service takes responsibility for managing the sales ledger and for collecting accounts receivable on behalf of the company.
A charge is made for the service, typically between 1 and 5 percent of the invoice amount. Initially, around 85 percent of the invoice amount is released to the business. Later, the balance less any interest, fees and other charges is settled when full payment is received from the customer.
For instance, a business raises a customer invoice for £20,000. This account payable is sold to an invoice financier for £17,000 (85 percent) with quick settlement. The factoring house then collects £20,000 due from the customer and then pays the supplier £3,000 less interest and fees when they receive the money.
Financial liquidity is improved; the regular flow of cash into the business’s bank account reduces bank interest and charges. The business also saves time that might otherwise be spent processing and chasing late payments, so reducing workload and extra administrative costs. It is then free to focus on productive core business activities.
Credit checks are carried out on some new customers to reduce any risk of payment problems. Because of this or through other business communication, the company’s customers may become aware that the business is using a financing service. Some of these customers also prefer to deal directly, not with third parties. It may be possible to work around this if the invoice financier provides a discreet service and presents an integrated image - some providers refer to their service as outsourced administration and credit control, rather than finance.
Usually, factoring is available for commercial (B2B) invoices, not to retail customers. It may reduce the availability of other funding as book debts are no longer considered as an asset.
Fees are charged based on the service and support provided but are a disadvantage, as they reduce overall business profit.
One very satisfied construction services supplier mentioned in a testimonial that in the building trade, it is crucial that the factoring provider understands the industry well. This executive went on to commend the specialist knowledge and service he had received for over six years. He also considered that without the cash flow advantages and other support received, he might not even have continued to be in business.
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