Invoice Factoring is a commonly used method of accelerating cash receipts from accounts receivable in some industries. It has traditionally been used by suppliers to retailers and other B2B seasonal industries, who need to keep a steady flow of cash to finance their operations. Invoice factoring is also sometimes used by companies that do not have the necessary resources to establish adequate accounts receivable and collection efforts of their own, and/or may not have access to other forms of accounts receivable financing. Following are some of the basics of invoice factoring.
When you use invoice factoring, you sell your invoice to a factoring company for less than face value or a discounted amount, which can be as little as 50-80% of the invoice amount. The amount of the discount is held by the factor until the invoice is paid. The balance less factoring costs, disputed amounts and returns is then paid to you. You will see later that factoring costs can be very high.
Normally the factoring company collects the invoices it has purchased, and customer remittances are paid directly to the factor.
RECOURSE AND NON-RECOURSE
If you sell invoices to a factor with recourse, then you are responsible for any unpaid balances. With non-recourse the factor is responsible for unpaid balances excluding disputed amounts and returns. Fees and discounts for non-recourse factoring are higher.
Normally a factoring program requires that you sell all of your invoices to a factor. In some cases factors will allow you to sell invoices for only certain customers, but only on a recourse basis. Factors do not want to purchase just your problem accounts.
The total cost of factoring an invoice can be over 5% of the invoice face amount plus fees and interest on amounts paid in advance. The cost depends on many factors including:
- Invoice amounts
- Credit quality of customers
- Your company’s credit quality
If factoring costs are 5% and you take advance amounts, then you will ultimately receive less than $950 for a $1,000 invoice. Depending on how long an invoice is outstanding this can work out to be a very high effective interest rate.
Since invoice factoring is a potentially very expensive way to accelerate cash flow from accounts receivable, many companies opt to use invoice financing, asset based loans or some other secured form of borrowing. With invoice financing you do not sell your invoices; they are used as security for the amount you borrow. Similarly, with asset based and other secured loans, invoices and other assets are used as security for the borrowing. You maintain control over your invoices and collect the accounts receivable.
Advances in accounts receivable automation have made it much less costly to establish and operate your own accounts receivable and collection department, especially with the availability of cloud-based software subscriptions. Compare the costs of invoice factoring versus collecting your own receivables and using them as collateral for a secured loan. You will be pleasantly surprised at how much you can save if you automate and collect your own receivables.
Lockstep Collect is a leader in cloud-based and premise-based software solutions made especially for businesses selling on credit.
If you would like to learn more about how you can benefit from automating your accounts receivable and collections, please contact Lockstep Collect at www.lockstep.io.