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Maintaining optimal cash flow is one of the many challenges of running a business. This is particularly the case with credit invoices. Liabilities restrict cash flow, but thankfully invoice factoring serves as a viable solution.

Offered by a majority of the financial institutions, this credit option gives you instant access to cash. To know more about this invoice factoring facility, read on.

How Does Invoice Factoring Work?

In simple terms, invoice factoring is when you sell your credit invoices to a factoring company. The company in turn gives you a certain value of your invoices as advance. The remainder of your invoice is paid when the factoring company receives the amount from the customer, the remaining amount will be paid to you.

The factoring company will pay the remaining amount after deducting certain charges, such as interest, factoring fee, etc. It is important to note that when you choose to factor your receivables, you will not receive the entire amount since the company will charge a fee for extending the facility.

Features of Invoice Factoring

Given below are the top features of invoice factoring:

  • Instant Access to Cash

A key feature of factoring accounts receivables is that you get instant cash by selling your invoices. This gives you cash inflow, enabling you to make timely payments and purchases as needed.

  • Different Types of Factoring

There are two types of invoice factoring – recourse and non-recourse. In the former, if the customer does not pay the invoice amount, you are liable to pay the amount. However, in the latter, the liability and risk lie with the factoring company. 

  • Charges

The factoring company will levy a certain amount for offering the facility. The amount may be based on several factors, including interest rate.

When Should You Use Invoice Factoring?

The main point or benefits of factoring receivables is that you get access to cash that would otherwise be tied up in liabilities. Given this, opting for this facility is best when you need immediate cash to make payments to keep your business operations running.

Alternatively, invoice factoring is a great option business that are starting out and do not have sufficient backing or credit history to avail loans. Factoring invoices is also beneficial for businesses looking to take advantage of new opportunities but don’t have the financing. 

It is important to note that in invoice factoring, your customers’ credit history holds more importance. This is because the ownership of the invoices gets transferred to the factoring company. 

Advantages of Invoice Factoring

Given below is an overview of the top benefits that you can enjoy with factoring receivables:

  • Quick Access to Cash

As mentioned, invoice factoring is a great way to access cash against your credit invoices. This enables you to maintain a balance in your cash flow and ensure that you can smoothly run your business operations.

  • Less Importance to Businesses Credit History

Since the factoring company buys the invoices from a business, the company will consider the customer’s repayment history and not the business’s credit history. Given this, it becomes a viable option for businesses who are trying to establish their footing.

  • Financing Without Incurring Debt

Invoice factoring is not a loan, as such the business does not incur any debt to get the financing it needs.

Disadvantages of Invoice Factoring

To make an informed decision, assessing the cons is as important as considering the pros. Given below is an overview of the disadvantages of invoice factoring:

  • Higher Costs

Factoring companies generally levy a higher interest rate, increasing the cost of availing the facility. Moreover, if the customer does not pay on time, the company may levy additional charges, which can add to the costs.

  • Less Control Over Customer Interaction

When the invoices are sold, the collection responsibility also shifts to the factoring company. As a result, the business has less or no control over how the collection requests get handled. This can negatively affect the reputation if the requests are too aggressive.

Process of Invoice Factoring

Given below is a step-by-step breakdown of invoice factoring process:

  • You raise an invoice for the sale of goods

  • You sell the invoice to factoring company

  • Post completion of the verification process, the company disburses the agreed amount

  • Customer pays the invoice the factoring company

  • The factoring company deducts any charges and transfers the remaining amount to you.

It is important to keep in mind that if the customer fails to pay the amount, the factoring company will levy an additional charge. Depending on the agreement, you may also be liable to pay the invoice amount if the customer does not.

Example of Invoice Factoring

Here is an example to help better understand how factoring receivables works:

Suppose you raise an invoice of ₹1 Lakh and take it to a factoring company. The factoring company will verify the necessary details and present the terms of offering the financing.

Generally, factoring companies initially offer only a certain percent of your invoice. The percent is mentioned in terms and can vary for each company. If the company offers 80% of the invoice value up front, you will get ₹80,000 against your invoice of ₹1 Lakh.

The remaining ₹20,000 gets paid when the customer makes the full payment. Remember, the factoring company will deduct a certain amount as it fees before transferring the balance amount.

Common Myths About Invoice Factoring

Listed below are common myths about factoring accounts receivables:

  • Factoring invoices requires good credit: Contrary to this belief, factoring invoices does not require a good credit on the business’s part but rather on the customer’s end.

  • Suitable only for entities that are struggling: In fact, invoice factoring is an option suitable for businesses of every size as it offers an easy solution to maintaining cash flow.

  • The cost is too high: While the factoring cost is on the higher side than the traditional credit option, companies can compensate for the same by increasing their costs.

How to Choose the Right Factoring Company?

Choosing the right factoring company is essential and you should consider the following points while deciding on the company:

  • The company levies nominal charges to keep the costs manageable

  • Offer higher invoice amount, allowing you to make the most of the facility

  • The disbursement process is quick and simple

  • Understand your business needs per your industry and specialisation

  • Levies fewer additional charges, which are disclosed at the start

Difference Between Invoice Discounting and Invoice Factoring

Below is an overview of the differences between invoice factoring and invoice discounting.

Point of Difference

Invoice Factoring

Invoice Discounting

Ownership of invoices

Lies with the factoring company

Lies with the business, i.e., borrower

Payment Collection Responsibility

Lies with the factoring company

Lies with the business, i.e., borrower

Control Over Credit

Lies with the factoring company

Lies with the business, i.e., borrower

Types of Invoices Accepted

Only select invoices are accepted

The business can choose which invoices to discount

Confidentiality

The business has to disclose the financing facility to the customers

The business can choose to not disclose the financing facility to the customers

While maintaining cash flow is crucial, it is also equally important to ensure that you make the right decision when it comes to factoring accounts receivables. This because the risks associated with it can quickly drain your finances, negating the main benefit of the facility.

Be sure to assess the costs and risks of invoice factoring before availing the facility. This is because with ideal use of the facility, you can boost the growth of your business and enjoy an increased limit in invoice factoring and establishing your creditworthiness in general.

FAQs on Invoice Factoring

How are companies eligible for invoice factoring?

To be eligible for factoring receivables, companies must meet the eligibility requirements set by the factoring company. A key criterion that majority of the factoring companies require businesses to meet is to have customers with good repayment and credit history.

 

Are factored receivables subject to taxes?

Factoring receivables is not subject to taxation for the entity receiving the financing. However, the factoring company may be liable for taxation for the fees levied by it.

What are the 2 types of invoice factoring?

The two types of factoring of invoices - non-recourse and recourse. In the former, the company offering the financing will bear the loss if the customer does not pay. However, in recourse, the business receiving cash against the facility will pay the invoice amount if the customer fails to do so.

 

What is the cost of factoring invoices?

The invoice factoring rates differ based on the factoring company and the amount of bills you factor. You can check the same before availing the facility.

 

What is the difference between invoice factoring and financing?

Invoice factoring is when the business sells its credit invoices to a factoring company and receives a fraction of the invoice value immediately. Invoice financing, or invoice discounting is when the business offers the credit invoices as security and avails financing in the form of loan.

 

Latest News Updates

By 2032, the Market for Invoice Factoring Will Experience Exponential Growth

Brainy Insights, a leading market intelligence company, has predicted that the market of invoice factoring, valued at $2.74 trillion globally in 2022, is expected to grow to a massive $6 trillion by 2032. This growth can be accredited to the adoption of natural language processing, artificial intelligence and machine learning worldwide. Additionally, the approach of collaboration that was adopted during the pandemic, with Supply Chain Finance (SCFs) and banks working together to help client ecosystems has contributed to the positive growth of the market.

- May 29, 2023

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