Introduction to Invoice Factoring
Businesses can access multiple funding options available in the Indian financial market. In the last few years, the number of institutional financing sources has also elevated significantly.
As a result, businesses can now resort to different financing sources to address their funding requirements. Such sources include:
- Investors
- Banks
- Non-banking financial corporations
Along with traditional funding options like mortgage loans or commercial loans, businesses can now shift their focus to other viable options like Invoice Factoring.
Considered one of the fast funding options to boost your business operations, Invoice Factoring is a common term among companies.
Read on to learn more about Invoice Factoring and how it impacts businesses.
Here are the key points to learn about Invoice Factoring:
- It enables businesses to raise money against the unpaid invoices
- It is costlier compared to other financing options for businesses
- Such funding options are helpful for businesses that do not qualify for conventional funding.
What is Invoice Factoring?
In simple terms, invoice factoring is a kind of invoice finance. It implies that you sell some of most of the outstanding invoices of your business to a third party in a bid to boost the cash flow.
The third party/factoring company pays you upfront for the invoiced bill instantly. It collects the payment from your customer directly. This leads to improvement in revenue stability.
Such a form of financing is prevalent in industries that do not get conventional financing solutions. Such types of businesses include:
- Staffing companies
- Logistics companies
- Consultants
- Attorneys
Note: Invoice factoring is also known as debt factoring or accounts receivable factoring.
How Does Invoice Factoring Work?
Here are the steps on how an invoice factoring works:
- Step 1: Finding a Factor: You sell goods and services to a customer in the traditional way. Then you invoice your customer for the sold goods or services.
- Step 2: The Factor Agreement: You sell the invoices to a specific factoring company. The company pays off the invoice amount, around 80-90% of the total value. The invoices are paid off once their validity is verified.
- Step 3: Assigning the Factor: The customers pay the factoring company directly.
- Step 4: Collection and Payment: The remaining invoice amount, minus the fee, is paid by the factoring company after they are paid in full.
How Much Does Invoice Factoring Cost?
It is one of the easiest business funding options to qualify for. It empowers you to get cash easily and quickly, compared to most client companies. However, the only issue is that it is one of the costliest forms of business financing options.
Here is a brief overview:
- Interest: The interest rate of factoring companies runs from 0.5% to 4% per month. It is quite higher than other conventional financing interest rates.
- Penalty fees: You are charged a penalty by the factoring company if the cheque of any of your client gets bounced or doesn’t clear.
- Limited advance rates: Most factoring companies advance 80-90% of your invoice value. The factoring company keeps the rest until the client pays the final amount.
- Late payment charges: You will be charged by the factoring company if your client pays the invoice after the due date.
- Wire transfer charges: Some factoring companies charge an amount to execute the wire transfers.
The factoring expenses can be quite bigger than other forms of financing. Even though there are ways to reduce costs, it depends on the factoring company. For instance, borrowers in specific industries may get lower interest rates than others. Not to mention, your fees get reduced the sooner your clients pay off their invoices.
Discount Rate
A discount rate is the transaction cost or primary fee of conducting business with a factoring organisation. It is also called the factor rate. Based on the factoring period and factor, it could vary from 2-10% of the invoice.
However, if there is a large amount of invoices in a given time period, the rate can go up significantly. Hence, it is always recommended to ask the factoring company how the discount rate is analysed and what can be done to get the best rate.
Factoring Period
It is the time when a factoring company enables your customer to keep the invoices open. This data is crucial to you since it will impact the final fee amount you need to pay.
At regular intervals, factors charge discount rates, usually monthly or weekly. Hence, the time your customer needs to pay the invoice will finally fix your final cost.
You must make the factor work and fix a feasible, realistic factoring period viable for you and your clients. This is because, if your client fails to pay the invoice on time, the factor could start accumulating from you to get their fees.
Note: Consider the time your clients take to pay your invoice while determining 1the costs.
Additional Fees
Along with the discount rate and the factoring tenure, factoring companies also charge some extra fees. Do not worry; all of that will be stated in your factoring agreement. The additional fees may include the following:
- Lockbox or Service Fee – A factor may keep a lock box to accumulate invoice payments for your particular account. To do so, factoring companies can charge a fee per month.
- Origination or Account Setup Fees – It is a one-time expense. These costs are linked with setting up new accounts while initiating a bond with a factoring company.
- Incremental Fee – In all the factoring agreements where the discount rate is flat, an incremental fee is applied. It will add to the total discount by a nominal percentage, generally not more than a 1% increase, depending on how long the client takes to clear the invoice.
- ACH Transaction Fee – It is charged for all the transactions between you and the factor comprising ACH transfers.
- Monthly Minimum Volume Fee – In case your invoice does not provide a particular amount of minimal fee per month, then a minimum volume fee will imply to you.
- Unused Line Fee – It applies to the average unused portion of the total factor line every month. To state, if there is an unused line fee and you fail to use the amount mentioned in your factoring agreement for a particular month, then a small fee will be charged. This fee will be taken out of your account.
- Renewal Fee – It is charged annually only when you wish to keep the factoring line open for one more year.
- Credit Check Fees – When a factoring company conducts credit checks on your customer or you, it incurs certain costs. These costs can be charged to you.
- Overdue or Collection Fee – In case a customer does not pay on time, and it calls for some action from the factor to take the payments, the factoring company may charge you the cost of such action. It is a flat fee and is applied only during missed payments.
- Non-recourse Factoring Fee – It applies in factoring agreements with a non-recourse clause. Such a clause means you will not be accountable if your client fails to clear the invoice. Several factoring organisations charge this fee for accepting this responsibility.
- Wire Fee – It is applied for every wire transfer transaction that occurs between the factor and you.
How Invoice Factoring is Being Used To Improve Cash Flow?
Here are some examples of how business owners can use invoice factoring to accelerate cash flow:
- Clearing rent and reoccurring bills
- Hiring and staffing new employees
- Purchasing more inventory to raise the margin
- Purchasing new equipment
- Investment in advertisement and marketing
- Accumulating capital quicker for the invoices that are unpaid
- Purchasing materials for projects
When Should your Company use Invoice Factoring?
A company should use invoice factoring when there are routinely several outstanding invoices, and the cash flow has been impacted due to it.
With invoice factoring, you can boost the cash flow instantly or at least some part of it. The money can be used to:
- Loan repayment
- Meet short-term costs
- Take benefit of business opportunities that arise seasonally.
- Resolve any issue that can lead to cash flow constraint
Now let’s learn about the primary benefits of using invoice factoring.
Advantages of Invoice Factoring
Here are the advantages of integrating invoice factoring:
- Easy application process
- Minimal qualification is needed
- Augmented cash flow minus any debt
- Easy cash flow boost
- Basic credit score requirements
- Less expensive than invoice financing
- Easy cash flow boost
- You can provide terms to your clients without any tension
- Good approval ratio
- No collateral required or personal guarantee needed
- Operational assistance to the A/R department
Now let’s learn about some of the disadvantages of invoice factoring.
Disadvantages of Invoice Factoring
Here is the list of the disadvantages of invoice factoring:
- Costlier than conventional business financing
- No way out for unpaid invoices due to default or late payment
- B2C who work directly with consumers do not have access
- Need to give up some authority over client interactions concerning A/R
- Liable for most cases that include non-creditworthy clients
What to look for in a Factoring Company?
Like several lenders, factoring organisations are available in all sizes and shapes. Every company has its strengths and restrictions. Every factoring company has its specialities too.
If you wish to integrate invoice factoring into your business to boost your finance, here are the things to consider before selecting a lender:
- Less interest rates – The interest on invoice factoring is usually relatively high. Hence, you must comprehend the rate charged by the potential company compared to the competitors.
- Quick Funding – A factoring company must provide fast access to your funds, usually within 1-2 days.
- Online invoice management – A feasible factoring company has online podiums. Here you can log in to check the invoice status. You need to submit the new invoices for factoring.
- Industry specialisation – Most factoring organisations specialise in different business sizes or industries. Hence, it is important to locate the one that better comprehends your requirements and industry.
- High advance rate: There is a limit levied by factoring companies regarding the advance provided to borrowers. This limit is regardless of the invoice size. Hence, you must work with a particular factoring company that allows you to access your money as quickly as possible.
- Few extra fees: Ensure that some uncertain charges do not blindside you.Trouble-free renewal method: Once you get a sanction to join hands with a factoring company, and it has sanctioned one of your customers, the procedure of factoring extra invoices must be swift and smooth.
How can Business Owners be Eligible for Factoring?
Factoring is an accessible working capital fix for small businesses, startups, and certified organisations. This solution is sold to creditworthy clients on credit.
Prominent and small business owners in all industries use factoring as a prime source of capital for:
- Trucking & Freight
- Construction
- Staffing
- Distribution
- Transportation
- Security Guards
- Manufacturing
- Apparel
- Commercial Service Providers
Other Typical Factoring Contract Provisions
Along with the service fee, a majority of the invoice factoring agreements also comprise the following:
- Recourse or Non-recourse FactoringRecourse factoring safeguards the factor when the receivable becomes overdue, requiring you to pay the advanced money. Not to mention, it generally needs you to have credit insurance to protect the factor’s risk of overdue. Your customers must be creditworthy to be approved by the insurance authority.
- Invoice Factoring Minimums – How many invoices do you need to factor in?Several invoice factoring contracts need a monthly minimum to be factored since the lesser the invoices, the bigger the operational costs will be for the particular invoice factoring enterprise. Usually, the minimums are set at the start of the relationship considering highly obtainable targets.
Why Choose Yubi?
Yubi is a tech organisation, committed to solving working capital problems for upcoming market SME exporters by using data and technology. Our web-based invoice finance solution can boost the cash flow in your business by selling your outstanding invoices.
In simple words, we deploy accessible and reasonable financing solutions to small and mid-sized companies.
FAQs
For some clients, invoice factoring may not go down well, since it includes third-party accepting payments on behalf of the borrower.
It depends on the financial company. It may take around 2-7 days, based on the application that needs to be executed, and additional days for loan disbursement.
It is possible to optimise business cash flow by availing the cash advances in exchange for the invoices prior to due dates. Your business can take advantage of the expertise of a factor on credit control, in case it is helpful for your company.
Invoice factoring is less uncertain than invoice discounting. Not to mention, invoice factoring offers high liquidity to businesses, around 85-90% that boosts the cash flows. Hence, Invoice factoring is a better option for your business.