Factoring and How Does it Work: A Quick Overview
The most common method businesses use to release cash from their debtors is factoring, also called invoice factoring. It is a way for businesses to raise money by selling their due invoices to the factor (banking institutions or factoring companies). Such companies use credit control services to help their clients improve their cash flow and revenue stability. This article is all about factoring and how it works.
What is meant by factoring?
Factoring, also referred to as invoice factoring, is a type of invoice finance where a company sells some or all of its outstanding invoices to a third party, known as a factor. Factoring further helps their clients to improve their cash flow. The third-party acting as a factor lends the company against their customer invoices, enabling it to receive most of the invoice cash value immediately rather than weeks or months.
Factoring is the subcategory of invoice finance, which is also known as accounts receivable factoring or debt factoring.
How does factoring work?
Factoring implies selling the control of a particular company’s accounts receivable, either in part or full. It works as follows:
- A company sells goods and services to its customers in a usual way.
- The same company invoices their customers for the sold goods and services.
- The outstanding invoices are further sold by the company to the factoring company. The bulk of the invoiced amount is paid immediately by the factoring company. Usually, such factors pay up to 80-90% of the invoices’ value only after verifying if the invoices are genuine and valid.
- Different methods are used by factoring companies to get payment from the company’s customers. The money paid by the customers is deposited in the factory’s official bank account.
- The factors pay the remaining amount to the company only after deducting their fee for the services offered by them Giniloh.
When should a company opt for factoring?
A company should opt for factoring services when it routinely has a lot of invoices outstanding and the cash flow is suffering because of the same.
For example, suppose a company sells goods and services on 30-day payment terms. Most debtors would pay before 30 days, while some might require chasing even after 30 days. That 30-day chunk of revenue might represent the company’s bulk of potential cash flow, but it can’t be used. In such a case, the factoring service allows the company to release that cash amount almost immediately.
The released money can be used by the company to:
- Bridge short-term expenses
- Take advantage of seasonal business opportunities
- Repay its debt, etc.
Invoice factoring can prove to be advantageous for companies as it helps with improving cash flow and reducing business overheads. Moreover, organizations can use the released cash from their debtors to expand their business. It is always recommended to research thoroughly a factoring company in terms of reputation, professionalism, and reliability bet6.