What is Invoice Factoring and How does it Work

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Invoice Factoring is a financial transaction where small businesses sell their accounts invoices to a third party for immediate cash.

In this case, the third party is the debtor finance. It funds small businesses using its accounts invoices as security.

This happens to small businesses with low capital income or paid on terms.

How do invoice factoring work

Invoicing factoring happens when companies are in goods and service business.

This means that payment is made once a service or goods are delivered, meaning that the company sends invoices to the clients for later payment.

Additionally, the factor who is the third party advances you the small business with 80% of the value of your invoice then you pay the remaining 20% once you have been paid by the client.

Here are steps to follow while doing an invoice factoring

  1. Invoice the clients

The first thing you do as a company., once you seal a business deal with the client you send an invoice for payment to them for goods or services provided.

The invoices should always be payable in 30-90 days.

2. Identify an Invoice Factoring  Company

Always start by identifying the best Factoring company that will work best with your business.

Then go through the terms and conditions required for you to qualify for the service then apply.

The factor will then determine whether your business qualifies for invoice factoring as well as do a background check on your clients and see their financial history

Based on that research, you and the factor will sign a financing agreement.

3. Sell the invoice to the Factor.

Once you have a financial agreement with the factor, you will now go ahead and sell the invoices to the factor at a discount.

The factor will then review the invoice submitted whether it is eligible then issue the 80% of the value of your invoice.

However, the advance will depend on the amount in your invoice.

4. Notice of assignment

Once you have assigned the financial agreement, the factor may ask you to send a note to your clients notifying them of the new agreement.

This is where you notify the clients of the new partnership with the factor who now create an account where all payments will be directed in the future.

5.Payment to the Factor

Once the notice of assignment is sent to the clients, the client will now be required to pay for the goods and services within the 30 or 90 days as stated in the invoice depending on the service offered.

6. Factor pays the remaining money

Once the client has honoured the payment agreement according to the terms and conditions of the invoice, the factor will now forward you the remaining 20% from the full payment.

Qualifications of Invoicing Factor

  • Must have been in business for at least two years non-stop
  • Must have invoices due within 90 days
  • Your business must not have serious tax or legal problems
  • You must be practising business to business (B2B) or government (B2G)

How to choose a good Invoice Factoring company

Here are some of the factors to consider while choosing an invoice factoring company

  1. Good customer relations

Considering that the Factor will be dealing with your clients directly as they make payments, it is very important that the factor you choose has good customer service.

In some cases, the factor may need to communicate directly with your clients as they verify the invoices as well as the assignment for the invoices.

2. Timely funding

Another important thing to consider is how timely the factor is in funding your business. This may be due to some of the urgent money matters that your company may require.

For example to pay employees, as a business you do not want a scenario where your employees will receive their payment late after working so hard.

Once you qualify for invoice factoring the funding should come as soon as possible could be even two to three days after.

3. Recourse versus Non-recourse factoring

It is very important you get to understand your factor very well in terms of recourses versus non-recourse.

This means that Recourse factoring can become problematic if you have already spent the money you received from the factor.

This is why you should only factor invoices to customers who reliably pay on time.

Some firms advertise non-recourse factoring, but then they list several reasons why an invoice can be exempt from no recourse. Other factors will offer partial recourse agreements.

This is why before you sign the Factor contract read it carefully and understand the terms in case of any misunderstands.

4. Spot Factoring vs Contract Factoring

Spot factoring allows you to sell and assign individual invoices to a factor, however, many factor companies do not advocate for this they always want contract factoring which is on a monthly bases.

However many businesses may have clients who pay on different times and their financing needs may change, making the flexibility of spot factoring a better option

5. Be familiar with the industry

Some Factor companies are not familiar with the industry most of their clients are in, Hence it is important to choose a Factor company that understands the industry to avoid conflicts.

Advantages and Disadvantages of Invoice Factoring

Here are some of the advantages

  • Quick money: In this case you are able to receive money as fast as possible to fulfil some of the business priorities rather than waiting for the client to pay after 30 0r 90 days.
  • Opportunity to get to work with the best financial experts: This means you get the best financial advice for your business from the expert
  • The creditworthiness of your customers is considered: With invoice factoring, your customer’s creditworthiness is more important than yours. This means you’re able to get financing even if you have poor credit.

Disadvantages

  • The factor may communicate with your customers: You can expect your invoice factoring company to contact your customers, and the level of interaction will vary by provider.
  • With an invoicing factor, the services may be more expensive
  • There is fear that your invoice may be sold to other clients

Also Read: Profitable Business Ideas in Kenya

 

 

 

 

 

 

 

 

 

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