What is Invoice Factoring & How Does It Help My Business?

Updated on: 04 Jan 2024 // 4 min read // Business Loans
Author :(466 posts)

When you are running a small business, a cash cycle is of paramount importance. As you do not have unlimited cash offers as compared to big corporations, your whole business is dependent on how soon your accounts receivables are realised.

You need the money to pay your bills, pay your suppliers, pay employee wages and manage various expenses. But due to increasing competition, it has become necessary for you to offer your goods and services to your customers on credit basis, ranging up to 90 days in some cases. But you need to manage your business and keep on supplying the goods and services. But you have already put in all your savings already and have no other means of finance ready with you.

You might think of going for unsecured business loans. However,if your business is new and you do not have a credit history, not many lenders Offer unsecured business loans. In such situations, one of your best options is Invoice Factoring.

What is Invoice Factoring?

Invoice factoring is a form of invoice financing, which enables you to improve your working capital by selling your accounts receivables to a factoring company. This way you get the funds against your invoices immediately, while the factoring company will get the payment from the debtors on the due date. One of the pre-requisites for invoice factoring is that the invoices should be from creditworthy and reputed clients with significant commercial value. It is more straightforward to get Invoice factoring done as compared to getting a loan, as here you will be selling an asset as against borrowing something.

How Does Invoice Factoring Work?

Invoice Factoring, commonly known as accounts receivable financing, is a process where you can get immediate finance for your funding requirements by selling off your accounts receivables to a factoring company. The whole process works in two stages:

Firstly, you would sell your invoice to the factoring company, who would pay you a certain amount in lieu of the invoices immediately. Depending on the terms and conditions of the factoring company you can get up to 90% of the value of the invoice immediately.

Secondly, when the due date arrives, and the customer pays the money against the invoice. The factoring company will pay you the remaining amount after deducting its financing charges.

The factoring company will verify your invoices before offering you an advance against the same. This is done in order to establish the validity of the invoices and identify any issues related to quality that may lead to stopping the payment. If the factoring company feels that they payment against the invoice could be doubtful, they will not offer you an advance payment against the same.

Invoice factoring comes handy when you or your business are ineligible for a bank loan and are in urgent need of money.

How to Qualify for Invoice Factoring

There are no major eligibility criteria that you must meet to be eligible for invoice factoring. But there are some basic requirements that every factoring company looks for, such as:

  • The customers you supply the goods on credit to, must be reputed businesses with good credit score or must be a Government agency. This ensures that your invoice would be honoured on time.
  • The invoices against which you are seeking advance payment from the factoring company must be payable within 90 days and should not be pledged as security with any financial institution.
  • The track record and credit history of your business should be satisfactory without any tax defaults or legal issues. Your credit score must also satisfy the factoring company.

Benefits of Invoice Factoring

Invoice Factoring is a handy tool for your business if you must sell your goods and services on credit but also require instant payment against your invoice. There are numerous benefits offered by Invoice Factoring that make it a viable option for small business owners such as you. Some of the significant benefits of Invoice factoring are:

  • Invoice Factoring provides you with immediate cash that comes in handy to meet your other funding requirements and makes sure that you meet all your monthly liabilities in a timely manner.
  • There is no lengthy process or documentation requirement for the loan processing. You just need to have an invoice payable from a reputed customer.
  • It does not add to your debt liability. Instead, you are getting a form of advance payment against your invoice which is due in a few days.
  • The only eligibility criteria are that your business must have a good credit score and the customer from whom you must get the payment should also be a reputed business entity or government agency.
  • You only need to pay a small financing charge to the factoring company against the advance payment. There is no need to pay any interest or any other costs.

Invoice factoring is a convenient and natural process that ensures that your business has ready access to a funding option to meet your monthly liabilities if you are not able to get an unsecured business loan.