What is Invoice Factoring and How is it Used?

Invoice factoring allows companies to raise finance on their accounts receivables and to hand over the credit collection to an invoice finance company.

It is a short-term funding option that frees up anything between 75% and 95% of the value of the invoice upfront. The balance is paid back to the company when the customer has settled the invoice, less the fee owed to the finance company.

Invoice factoring differs from invoice discounting in that that the factoring company takes over the entire debtor’s book and takes control of the invoice payment process, following up with customers to secure payment.

Invoice factoring is useful in that it enables small businesses to unlock the funds that are tied up in unpaid invoices. It also frees up the time and resources taken up in the invoice payment process. For a business owner of a small company this can be time consuming, particularly if the company doesn’t have dedicated resources to manage the accounts. By outsourcing this to an invoice finance company, the owner can thus focus on pursuing growth opportunities for the company, confident that the invoice finances that are the lifeblood of the business are being handled efficiently.

To establish an invoice factoring contract, a company needs to do the following:

• Identify a reputable invoice finance company that offers a competitive, cost-effective factoring service. You will need to shop around to compare quotes and understand how the finance company operates and whether you are happy with them representing your company in the collections process.

• Hand over their invoice financing book to the factoring company for assessment. Invoice finance companies are usually only willing to fund invoices that are payable in less than 90 days and will scrutinise the payment history of the customer base.

• Draw up a factoring contract with the invoice finance company to take over responsibility for funding and managing the payment of invoices for a fixed, pre-negotiated term.

• The invoice finance company will contact customers to let them know that they have taken over the invoicing process on behalf of the supplier and that they are the party that will need to be paid in the transaction. The company can enter into a confidential contract in which the customers are not aware of the fact that the invoice financing process has been handed over to a third party. Companies who prefer to maintain the relationship with the client and are concerned that they may be seen as heavy handed by introducing a third-party to the payment process can opt for a confidential arrangement. However, if factoring is common in your industry, customers are likely to be familiar and familiar with these arrangements.

• Once the contract has been finalised, the finance company verifies the invoices and then releases a proportion of the invoice, up to 95% of the value of the invoice depending on the agreement negotiated with the finance company, at the outset.

• The invoice finance company chases payment of the remainder of the amount owed and, when received, the balance, less the fees, is paid into the company’s account.

Invoice factoring is a valuable service for many small to medium sized companies that face the challenge of maintaining healthy cash flows during the first few years of operation and during expected and unexpected slow periods, such as the festive season, thereafter. It is easier to get access to invoice finance than applying for traditional bank loans, which take time to set up and require more documentation. Invoice finance is quicker, more effective and flexible enough to suit your particular business circumstances.

Companies contemplating whether to opt for invoice factoring as a means of financing their invoices do need to consider whether they are happy to engage in a more formal, contracted relationship regarding their entire account receivables book. There are other more flexible options, such as discounting, which contracts the finance company to fund the invoices but not to secure payment.

Both options offer small to medium sized businesses valuable funding resources. Invoice factoring or discounting allows business owners to focus on building their business on a firm financial foundation, without having to worry about whether cash flow constraints could potentially undermine their financial success.